Discussion:Charitable Remainder Unitrust forms - taxation of annuities for non-natural owners
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Discussion Forum Index --> Tax Questions --> Charitable Remainder Unitrust forms - taxation of annuities for non-natural owners
| 11 April 2007 | |
| I have filed Forms 5227 and Form 1041A for several years now for a CRUT. However, I just ran across an article online that said a Schedule K-1 needs to be filed with the Form 1041A. I have never filed a Schedule K-1 with the Form 1041A as the instructions never said to do so. The income from the CRUT is a variable annuity and the taxable portion varies from year to year. I prepare the Form 5227 showing the recipients name and tax id number and the amount of the taxable portion and the amount that came from trust corpus and likewise I put the taxable portion on my client's (the beneficiaries) Form 1040 on line 16 Pensions and Annuities.
Am I supposed to be filing a Schedule K-1 with Form 1041A? The IRS has never sent a notice saying to do so. Thank you. | |
| 11 April 2007 | |
| Split-Interest Charitable Trusts
yes, a K-1 goes to the present interest (income) recipient | |
| 11 April 2007 | |
also, how are you calculating the income from the VA?
It is NOT the amount on the 1099-R. In my professional opinion, annuities should not be held inside a CRUT. | |
| 11 April 2007 | |
| The investment company the annuity is with issues a Form 1099-R each year, however the taxable amount is never correct. I have been tracking the cost basis each year and I have determined the taxable amount of the distributions each year. On the Form 1099-R the gross distribution matches the 7% unitrust amount that is required to be distributed. Each year I have to contact this investment company to get the necessary information I need to calculate the taxable portion. I really don't feel they know how to handle this CRUT.
Since I have never prepared a Schedule K-1 in the past to go with the Form 1041A, will this trigger any sort of correspondence from the IRS if I start doing it now? | |
| 11 April 2007 | |
No, just do the K-1.
Please review carefully the annuity taxation rules for contracts owned by non-natural persons. You will be surprised. First, read Sec. 72(u)(2) | |
| 11 April 2007 | |
| Third, Read this | |
| 11 April 2007 | |
| ***SURPRISE*** It may be more or less than the distribution from the contract. It could even be negative (remember those years the stock market went down?).
Now you need to go back and amend all those returns. Fun, huh? | |
| 11 April 2007 | |
| (for those interested in learning about CRUT tax returns, attend my session at NATP's conference this July - see my user page for the link Kevinh5) | |
| 11 April 2007 | |
| **SFB CPA** as an aside, who/what firm was the financial planner with who recommended the use of a VA inside a CRUT and how long ago was it purchased? Contracts pre Feb 28, 1986 are taxed differently. | |
| 11 April 2007 | |
| I took this client on well after this CRUT was in place. I picked up where the other CPA left off. It was not a return I would have picked to do, but my client could not find anyone to prepare the CRUT tax returns for her. I did quite a bit of research and was always confused as to why the CRUT held the funds in an annuity, but figured the investment guys knew what they were doing...I have since not been so confident of this.
Thank you so much for your valuable information. She has since gone with a new investment advisor and I will pass along this information to him. I guess this one is going on extension until I can get it sorted out. :) | |
| 11 April 2007 | |
| The CRUT was established in 1995 and that is when the assets were put inside the CRUT. | |
| 11 April 2007 | |
| I would bet that the tax returns have never been correct. No offense to you, but shame on the person doing the first return for not doing research first and shame shame shame on the original financial advisor for not knowing either. | |
| 11 April 2007 | |
| I reviewed some of the information you brought to my attention (a little busy to do this all at the moment) and I cannot find anything that says a Schedule K-1 needs to be issued. Also, the tax packet that my client receives for Forms 5227 and Form 1041-A never include a Schedule K-1. My tax software (ProSeries) does not handle these forms so I have to download them from the IRS website and the Schedule K-1 is not mentioned in the instructions for Form 1041-A.
Where does it say that a Schedule K-1 is required to be filed with these forms? | |
| 11 April 2007 | |
| The K-1 is the only way that the income recipient knows what type of income he is receiving - interest, dividends, or other ordinary income; cap gains (ST or LT); tax-free; or non-taxable. This is sometimes referred to as the 4 tiers of income. | |
| 11 April 2007 | |
| 5227 Instructions See page 3 where it specifically mentions K-1 forms. And page 5 where it says to give a K-1 to the income recipient and attach a copy of K-1 to the 5227.
Not that I have ever been fond of instructions myself. | |
| 11 April 2007 | |
| I suspect that since none of those prior tax returns have been computed or filed correctly, that the IRS does not know the difference (yet, until you do a correct return now), but it is really not "pensions and annuities" when it comes out to the income recipient, but "other ordinary income". | |
| 11 April 2007 | |
| You are welcome. Good luck and I hope you charge plenty, because these are NOT easy. My software doesn't do them either. | |
| 12 April 2007 | |
| The 1041A is an information return, not a tax return. The K-1's come from the 1041. | |
| 12 April 2007 | |
| and the 5227. The fact remains that income was not properly reported on the 1040 because of the improper recording of the annuity "income" inside the trust. This would affect future years as all ordinary income may not have been distributed each year. If so, future distrubions may be ordinary income instead of capital gain. | |
| 12 April 2007 | |
| The 5227 is also an information return. The only form that issues K-1's is the 1041. Bear in mind that there are circumstances where these trusts can be taxpayers as well as distributing income. | |
| 12 April 2007 | |
| Dennis, you have probably read the instructions I provided a link for, specifically page 5 where it says to prepare and attach a K-1 and attach a copy to the 5227? | |
| 12 April 2007 | |
| Yes Kevin, but the K-1 you attach is specifically a Form 1041 K-1. There are no K-1's from a 1041A or a 5227. The requirements for filing 1041A and 5227 do not waive the requirement to file a 1041. Information returns are not tax returns. | |
| 14 April 2007 | |
| So am I understanding it correctly that unless there is UBI that there is no requirement that a Schedule K-1 be filed since there is no requirement that a Form 1041 be filed? | |
| 14 April 2007 | |
| So do you mean "no" I am not understanding it correctly, or that there is "no" requirement to file a Schedule K-1 unless it is required that Form 1041 be filed? Sorry...I have researched this to death and am getting more confused! | |
| 14 April 2007 | |
| Gift Law Pro | |
| 14 April 2007 | |
| That was very helpful. So as I understand it, the Form 5227, Form 1041A and Form 1041 Schedule K-1 must be filed but Form 1041 is not required because this CRUT did not have UBI.
Thanks. | |
| 14 April 2007 | |
| No. You file a 1041. They tell you it is not required, but it is the easiest way to provide the income beneficiary (and the IRS) with the information needed to file his tax return and produce the K-1 for attatchments. | |
| 14 April 2007 | |
| Thank you. That is what had me so confused is that it said a Form 1041 was not required but also said to issue K-1's. Thank you Thank you! | |
| 15 April 2007 | |
| I don't agree with the statement that a 1041 is always required. The website link provided by Dennis even states that it is only required if the trust has UBI. Maybe the ones he has seen have always had UBI and required a 1041. None of the ones I have seen have. For a few minutes I was worried I had made a mistake, but I have the confirmation of a national tax organization to back me up when I say that you usually don't need the 1041. | |
| 15 April 2007 | |
| The 1041 is not "required". This is after all a tax exempt trust. On the other hand you still have to prepare it to produce the K-1.
What you do with a tax return after you've prepared it is your business. I file them. | |
| 23 April 2007 | |
| Hi Kevin,
I have recently inhertited a client that has an annuity inside a CRUT as well. I read the discussion above and I'm trying to make sure it is reported correctly on the tax return. One question I have: Under IRC 72(u)(2) there is an exception for an "immediate annuity" under 72(u)(3)(E). If a CRUT takes sales proceeds and purchases an annuity, would this be considered an immediate annuity for these purposes? The definition at 72(u)(4)seems like it fits, but I'm not sure. I did look at the PLR and other cites above. The returns for the client I inherited have shown the increase/decrease in FMV as other income on the trust, but still flowed out the actual unitrust distribution to the beneficiary on the K-1. | |
| 29 April 2007 | |
| An immediate annuity is one where the annuitized payout begins within 1 year from the purchase date - usually they begin the next month. Most annuities purchased today are never annuitized, but only have withdrawals taken. | |
| 4 May 2007 | |
| It's me again. I was also wondering about the immediate annuity exception. The annuity that is held by the CRUT did start paying out immediately with a 7% distribution per year. This may sound dumb, but what do you mean by most annuities purchased today are never annuitized?
Also, what would you recommend if my client's investment advisor doesn't get me the information I need to figure out the income? He doesn't seem to understand what I need. | |
| 4 May 2007 | |
| 1) Most annuities are purchased and instead of getting a regular check every month (annuitized) for either life or a term certain (10 or 20 years being the most common), people just take out $5,000 here and $10,000 there as needed. The whole §72 must be understood when you really want to know about annuities. Under the rule for annuities that are not annuitized, for natural persons these are taxed as last-in, first out (for post 198X contracts - speaking from memory now so don't have the exact date in front of me). That means if there is $20,000 worth of "gain" inside an annuity and someone takes a $10,000 withdrawal, all $10,000 of the withdrawal is taxable income.
For annuities owned by non-natural persons (including trusts with non-natural beneficiaries and corporations), annuities are not taxed at all like annuities - i.e. there is no tax-deferral. They are taxed on the gain or loss inside the contract each year. 2) Thus, you need the Dec 31st statement for the annuity held by a CRUT or other non-natural person. The income (all ordinary) will be the difference (positive or negative) between last 12/31 and this 12/31 after taking into consideration payments received during the year. Income is deemed distributed from the CRUT under the 4 tier rule, but in the first tier (ordinary income), all other ordinary income is deemed distributed before dividends. Thus the highest taxed income is always distributed first.
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| 4 May 2007 | |
| I want to warn you that this annuity you are speaking of may not be annuitized, just 7% withdrawals taken - you need confirmation that it has been annuitized before going further. | |
| 4 May 2007 | |
| Oh, the part I wrote about almost being able to do an amortization schedule - that would apply to a fixed immediate annuity, not a variable one. Sorry if I sent you down the wrong path for a minute or two. | |
| 4 May 2007 | |
| Therefore for an annuitized variable annuity held by a non-natural person, you would still tax any ordinary income even if not distrubited that year. Thus one of my very first answers to your question - the income is NOT what is reflected on the 1099. | |
| 4 May 2007 | |
| I'm not so sure about that. Bit outside what I normally do, but personally I've never seen an annuity remain variable after annuitization. It would seem the insurance company would be accepting a transfer of risk. | |
| 4 May 2007 | |
| There is something called "variable annuitization" that allows the annuity to still be invested in separate accounts. The sum is converted into "units" and the value of these units goes up and down daily. The payout is so many units per period, thus the payout can vary. That's the theory, the reality is that the change is usually only done once a year. An "Assumed Interest Rate" (AIR) is chosen and payout is based on that. If earnings are greater than AIR, then the payout in the next year is increased. If the earnings are less than AIR, then the payout is decreased. | |
| 4 May 2007 | |
| OK. Doesn't seem to fit the fact pattern, though. How would the income interest benefit? | |
| 4 May 2007 | |
| Dennis, please expand your question so I can understand what you are asking. Are you asking how the income beneficiary benefits from the CRUT owning an annuity (versus some other form of investment)? Are you asking how much is the income for the income beneficiary? What are you asking? | |
| 4 May 2007 | |
| The unexpired interest of the unitrust is either going to benefit from the election (by receiving the potential for an increased payout) or not. It would seem that if he does, the trust is acting as his agent and the non-natural rule doesn't apply. | |
| 4 May 2007 | |
| I don't see how this is any different for the charitible remainder beneficiary than investing in Google stock - if it goes up more than 10% a year the charity would receive a windfall. If it goes up by only 1% then not.
The 10% to charity rule is only at the valuation of the contribution to the CRUT - more or less will always go to the charity because you can't predict with any measure of precision (other than by the mortality tables) when the income beneficiary(ies) will die and how the investments will perform. No? | |
| 4 May 2007 | |
| I DO see that if the annuity ends at the death of the income beneficiary then there is nothing for the charity. | |
| 4 May 2007 | |
| I hold that because of the taxation of annuities by non-natural persons (and the potential for the annuity to be set up incorrectly to end at the death of the income beneficiary) that they are not appropriate holdings for a CRUT anyway. I am not going to defend their use, I am only trying to explain the taxation of them. | |
| 4 May 2007 | |
| Really. Given the the number of charitable gift annuities out there that seems rather silly. In general, so long as they are in distribution, annuities make CRUT administration easy. I do have a variable annuity inside an OBRA '93 trust. The attorney holds that trust is agent for the disabled individual and the annual change in value is not taxable (although I do report it as income on the annual accounting to the Court). | |
| 4 May 2007 | |
| There is nothing that says a CRAT or a CLAT has to use an annuity as the investment vehicle. The "annuity" in the term Charitable Remainder (or Lead) Annuity Trust refers to the fact that a fixed amount per year will be paid from the trust. It has nothing to do with how the corpus of the trust is invested. A very common misconception by many financial advisors who don't do taxes. (Especially if they sell annuities).
The "look through" rules for trusts probably apply to the trust you are discussing - the real beneficiary is a natural person. In a CRUT, all of the beneficiaries are NOT natural persons. | |
| 4 May 2007 | |
| Contrast the CRAT (fixed amount payable per year, thus the term annuity), with the CRUT, where the Unit/Uni amount is a fixed percentage of the beginning amount each year. | |
| 4 May 2007 | |
| Also, I don't see how annuities inside a CRUT would make administration easy. The CRUT must pay a fixed percentage out each year to the income beneficiary. What if the annuity doesn't pay out that much money? Where will the rest come from? | |
| 5 May 2007 | |
| In the ones I've seen, the vehicles had a purpose (sale of appreciated property). Once the purpose was accomplished corpus was annuitized at the unitrust rate. Seemed nice and simple to me. | |
| 5 May 2007 | |
| how did they ensure that something was left for the charity? Only annuitize 90% of the contribution? | |
| 5 May 2007 | |
| My recollection is that the unitrust rate was part of an agreement with the insurance company such that the annual surrender value was constant. The attorney's position was elimination of administration was effectively income and given what goes on with the the one unitrust I can't get out of (Every three months the poor guy goes nuts trying to decide what stocks to sell.) it is a point to consider. | |
| 9 May 2007 | |
| I have a very interesting and also very sad recent development. My client has just passed away unexpectedly that was the beneficiary of the CRUT and the successor beneficiary is her daughter. Her daughter has just retained an attorney who is looking into settling with the charity involved in the CRUT and disposing of her interest in the CRUT. I have informed her that I do not think this is such a good idea. I researched it for her to determine what her taxable gain would be and I ran across Ltr. Rul. 200314021, which stated that 100% of the amount distributed to her will be treated as long-term capital gain. Am I interpreting this correctly and is this a good idea for her to dispose of her interest and settle with the charity? This was so unexpected and so very sad. | |
| 9 May 2007 | |
| It also goes against the mother's wishes that the daughter receive an income stream for life. I haven't read that ltr. rul. yet, so I'll have to get back with you when I do. Generally, if there is any accumulated ordinary income inside the crut, that would be deemed distributed first.
Normally, you would have to get a PLR stating that the termination is acceptable (which has normally been granted as long as the charitable beneficiary gets what they are supposed to get). | |
| 9 May 2007 | |
| Unitrust termination is pretty much established law since the dot.com collapse. It is done using the §7520 tables and the income interest held by settlor has a zero basis. In this case I would assume the income interest would receive a step up to present value as at date of death. | |
