The term "fiduciary" applies to a person(s) who occupies a position of special confidence toward another, who holds in trust property in which another person has the beneficial title or interest, or who receives and controls the income of another. Thus, trustees and executors are considered fiduciaries.
A fiduciary must file a return for the trust or estate if:
- the trust has any taxable income or has gross income of $600 or more, regardless of the amount of taxable income;
- the estate has gross income of $600 or more;
- any beneficiary of the trust is a non-resident alien.
The return must be filed on or before the 15th day of the 4th month following the close of the taxable year. In filing its first return, an estate may choose the same accounting period as the decedent, or it may choose any fiscal year it wishes.
The fiduciary of a domestic decedent's estate, trust, or bankruptcy estate uses Form 1041 to report:
- The income, deductions, gains, losses, etc. of the estate or trust;
- The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries;
- Any income tax liability of the estate or trust; and
- Employment taxes on wages paid to household employees.
Income Taxation of Trusts and Decedents' Estates
A trust (except a grantor type trust) or a decedent's estate is a separate legal entity for federal tax purposes. A decedent's estate comes into existence at the time of death of an individual. A trust may be created during an individual's life (inter vivos ) or at the time of his or her death under a will (testamentary ). If the trust instrument contains certain provisions, then the person creating the trust (the grantor ) is treated as the owner of the trust's assets. Such a trust is a grantor type trust. See page 5 for special rules for grantor trusts.
A trust or decedent's estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, there is one major distinction. A trust or decedent's estate is allowed an income distribution deduction for distributions to beneficiaries. To figure this deduction, the fiduciary must complete Schedule B. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries.
For this reason, a trust or decedent's estate sometimes is referred to as a “pass-through” entity. The beneficiary, and not the trust or decedent's estate, pays income tax on his or her distributive share of income. Schedule K-1 (Form 1041) is used to notify the beneficiaries of the amounts to be included on their income tax returns.
Before preparing Form 1041, the fiduciary must figure the accounting income of the estate or trust under the will or trust instrument and applicable local law to determine the amount, if any, of income that is required to be distributed, because the income distribution deduction is based, in part, on that amount.
"Accounting income" is theoretically supposed to represent the interests of the INCOME beneficiaries of the trust (as opposed to the residual beneficiaries, who receive distributions of corpus, or principal, upon trust termination). Accounting income typically includes items such as dividends, interest, rent receipts by the trust, etc., i.e., current return received by the trust from assets that are already held within the trust. It CAN also include capital gains and mutual fund capital gain distributions, if the trust instrument so provides, but these items are more commonly considered adjustments to corpus, or principal.
In preparing Form 1041 for an estate, or for a trust that acts as a vehicle for distributing all of the decedent's assets to the beneficiaries soon after death, it frequently makes little difference whether changes in value from the date of death to final distribution of all assets are allocated to income or principal, since often the same beneficiaries receive both the decedent's assets (principal) and any earnings thereon that occur subsequent to death but before asset distribution. However, in an ongoing trust having separate income beneficiaries and separate residual beneficiaries, it is important for the trustee to be able to distinguish between what is considered income and what is an adjustment to principal. Almost all states have adopted a version of the Uniform Principal and Income Act, which provides guidance in this regard in the absence of specific language in the trust document.