accountants guide to grantor trusts 111714

ACCOUNTANTS’ GUIDE TO GRANTOR TRUSTS
Naperville, Illinois
November 17, 2014
1Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C.
All Rights Reserved
Scott M. Pohar
Frost, Ruttenberg & Rothblatt, P.C.
spohar@frrCPAs.com
847/282-6324 Phone and Fax
www.frrCPAs.com
NBI
NATIONAL
BUSINESS
INSTITUTE TM

Outline of what we will discuss
A. Current Federal and State Tax Regimes.
B. Calculating Taxable Income
C. Accounting Income vs. Taxable Income
D. Grantor Tax Information Letter
E. Reporting Trust Income
1. Using Form 1099 instead of Form 1041
2. When must you file a 1041?
3. How to report trust income on grantor’s Form 1040.
4. Estate Form 1041 (Pre and Post Death)
5. Beneficiary Reporting 1040/1041.
F. How to change from Form 1041 to 1099.
G. Pease limitations on Itemized deductions, 3.8% Surtax and Other
individual tax changes that may affect Grantor Trust Taxation.
All Rights Reserved

Advantages of Grantor Trusts
• Helps to avoid probate.
• Can avoid guardianship in cases where all assets are
held in trust.
• Can trap income to the grantor, while growing the
assets free of estate tax.
• Can be an asset protection vehicle in some cases.
(Irrevocable Grantor Trusts)
• May help trust to achieve non-passive status under the
3.8% net investment income tax.
Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All
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Must you file grantor trust returns in
States?
• If you have chosen the option to file a Form 1041
instead of the alternative options, then usually you
must file a return in the state or states where you have
source income, or are a resident.
• Many exceptions to the above rule.
– IL does not require the filing of a grantor trust.
– Some states have rules to file if the income is greater than an
amount.
– Must look to the instructions for the various states if you have source
income to that state, or the trust is a resident of that state.
– Be careful with regards to residency. Some states are based on
where the trustee is located, or where the trust is formed, and some
are based on where the beneficiary lives.
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Calculating Taxable Income
• Trusts generally follow similar rules to an individual
return, however, it can be like a partnership if the
income is distributed to the beneficiaries or a mixture
of the two.
• The income of grantor trusts is taxed on a gross basis
to the “grantor”.
• Grantor trust rules are in the code under sections 671-
678.
• Non-grantor trusts are tax on a net basis – Income is
netted against deductions and taxed or distributed
proportionately.
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(continued)
• Non-grantor trusts have different exemptions as
follows:
– Complex Trust (Usually $100, but can be $300 if certain
requirements are met)
– Simple Trust $300
– Estates $600
• Capital Gains are usually taxed to the trust
- Should review the trust agreement to see if gains can be allocated to
income
- Can’t pass out capital losses except in a final return
.
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(continued)
• Expenses:
• Grantor trusts are displayed on the grantor letter in total and then
reported by the Grantor on his/her individual tax return in the proper place
• Expenses Non-grantor trusts:
– Some expenses, like attorney and accountant fees, are not subject to
2% of AGI. Other examples include casualty and theft and domestic
production deduction.
– Only expenses for the production or collection of income is subject to the
2% of AGI Limitation.
– Expenses are netted when allocating income to the beneficiary.
(This reporting does not further limit the deductions under the limitation
of itemized deductions, Pease rule)
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Accounting Income vs. Taxable Income
• Trust accounting income is a concept that is
sometimes misunderstood amongst trustees.
– It is a cash basis concept focusing on cash receipts and disbursements.
– Can be governed by the trust agreement.
– If no mention in the trust agreement, look to state Principal and Income
statutes to determine what is income and principal.
– Does not apply to the taxation of grantor trusts, but can apply to the
distributions from grantor trusts. So a defective grantor trust will have
specific language regarding distribution provisions, which must be
followed and which will have a definition of what is income and what is
principal.
– What if the trust is only part grantor trust?
– See list of income and principal under IL code in book
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Requirements to file a trust return
(all trusts)
• Domestic Trust
• At least $600 of gross income
• ANY taxable income or
• A non-resident alien beneficiary
• A Grantor trust, has no exemption and all deductions
pass through as deductions instead of as a net
amount so any income is considered taxable.
• If you are going to file a Form 1041, get an EIN when
formed.
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What types of grantor trusts require
you to file a Form 1041?
• If all income is reported in an EIN. I see no reason to
use the 1099 method, and so I always prepare a
grantor return when the income is reported in EIN.
• If return is partially grantor, you will need to file a
grantor letter with the return. Examples include a
QSST, or whereall income is grantor, but principal is
not.
• Grantor Type Charitable Lead Trust(CLT) (You will
also need to prepare a Form 5227)
• Trusts with more than 1 grantor, exception being a
husband and wife.
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What types of grantor trusts require you to
file a Form 1041?
(Continued)
• A foreign trust.
• A common trust fund (almost no longer used)
• A trust where the grantor is not a US Citizen.
• The grantor must be on a calendar year end. Since a
grantor trust must be on the same year end as the
grantor, and if the grantor is on a fiscal year, then a
trust return must be filed to report the income.
• Check with attorney to see if there is another reason to
file the return. Some attorneys believe that asset
protection is a good reason to file a separate return.
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What are the Alternative Reporting
Methods?
• No return method
• 1099 method
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1099 Alternative Method
• 1099s in the EIN of the trust are then reported on a
1099 in the name and SSN of the Grantor.
• Trustee must also give a list of expenses to the
Grantor incurred by the trust.
• Trustee who is not a grantor must produce a report
showing the income and expenses.
• Hardly ever used since most believe you can just as
easily file a Form 1041 as a separate 1099.
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Reporting in SSN of Grantor
(No return method)
• Give payors of income the SSN of the grantor and the
name of the trust as the owner.
• Give them a W-9 if required.
• All income will be reported in the SSN of the grantor.
• Trustee, if other than the grantor, should provide a
report of income and expense for the year paid by the
trust.
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Form 1041 Filed
• If you haven’t elected an alternative filing procedure
then file a Form 1041.
• Due date is 3 ½ months after the
• Page 1, shows grantor trust language if only a grantor
trust.
• If the trust is part grantor trust, then file either a simple
or complex then add the grantor letter to the back. In
this case you will need to check multiple boxes.
• Some states don’t require a Form 1041 to be filed, like
IL.
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Form 1041 Filed
• Section 179 expense is normally not deductible by a
trust. However, a grantor trust is considered a pass-
through entity so it can be deducted by the individual
flowing through a grantor trust.
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How to report the income on the
Grantor’s Individual Return
• Reporting can be slightly different depending on
whether you have elected the alternative reporting or
filing a 1041.
• Interest and dividends will be reported on Schedule B.
• Capital gains on schedule D. If I file a 1041 and show
the itemized sales, then I don’t report them the same
on the 1040. If you are just getting a 1099, then you
will report as if they are owned by the individual.
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Form 1040 reporting
• Section 121 exclusion for selling the principal
residence, may or may not be available. If it is a
revocable grantor trust, then you can use the
exclusion. If it is irrevocable, like in a QPRT, the
exclusion is not available. If the trust is a grantor trust
under Section 678, this might allow you to use the
gain exclusion.
• K-1s, many times we attach a statement to the return
to indicate the attached K-1s will be reported on the
grantors income tax return. Then we report the K-1 on
Schedule E.
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What happens when someone dies?
• Get new EIN for the trust.
• Determine if you will elect Section 645 to report the
grantor trust as part of the estate.
• Determine what tax year to then report the income
realizing you can’t go more than 1 year past death.
• Income and expenses need to be split between pre
and post death for tax reporting. Sometimes we
allocate based on the number of days in the year, but
we usually try and do better by getting a broker
statement as of the month of death.
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(Continued)
• If the trust contains assets of the survivor spouse, then you
will split off the survivor assets into a separate survivor’s
grantor trust. This can happen when the attorney sets up a
Joint Grantor Trust, or in a community property state, like
California.
• Normally, the successor trusts, which usually aren’t grantor
trusts, will split into a family trust and/or a marital trust. The
marital trust could be a grantor trust if the surviving spouse
has a general power of appointment over the trust both
during life and at death, or if she has an unlimited power to
apppoint income and/or principal to herself as trustee.
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(Possible 645 Election)
• You will need to determine if you want to make a 645
election for the trust. Under IRC Section 645, the
grantor trust and the “administrative trust” can be
combined into one return after death. The benefits of
making a 645 election are:
– Fiscal Year
– One return if you have assets in the estate and the trust
– Can continue to own S-corp stock during the estate administration
– Can take a charitable set-aside deduction only allowed to estates.
– Push income to a later tax year.
– No estimates for two years
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(Possible 645 Election)
• This is can be a very powerful election, especially if
you have IRD or can take a charitable set-aside.
However, there are some negative impacts so we use
it sparingly:
– More difficult to prepare return (1099s aren’t enough information)
– Must end after estate administration:
• Lesser of two years or 6 months after estate is settled by a
closing letter
- Will have to file two tax returns in one year if trusts are funded
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Case Study showing Reporting difference
between individual and trust
Individual Return (Grantor Trust)
Schedule A Taxes $12,500.
Schedule A Misc Expense(2%) $14,000.
Schedule B Interest $2,500.
Schedule B Dividends $3,000.
Schedule D – Short Term $25,000.
Schedule D – Long Term $29,500.
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Case Study showing Reporting difference
between individual and trust
Tax Reporting if a non-grantor trust to individual:
No Income will be reported to a beneficiary since the
expenses would wipe out all Distributable Net Income
(DNI). Actually if Income or Principal distributions
were made, the K-1 would show an AMT Adjustment
of $5,500.
Tax to Trust (Assuming Capital Gains are not DNI):
Short Term Gain $ 4,000.
Long Term Gain $29,500.
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How to change the Grantor Trust
reporting method from 1041 to No return
• Notify the payors of income to change the EIN to the
SSN of the grantor. Leave the name of the trust as
the owner.
• File a Final Form 1041 using the EIN of the trust by
checking the final return box on page 1 of 1041.
• Attach a statement to the final return stating:
– “Pursuant to Reg. 1.671-4(g), this is the final Form 1041 for this
grantor trust.”
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How to change the Grantor Trust
reporting method from No return to 1041
• Apply for new EIN.
• Notify payors of income of the new EIN and provide
them with a Form W-9.
• File a Form 1041 with the “initial return” box checked.
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Tax affects of various items on
Grantor Trusts
• Pease Limitation: This has no affect on any trusts
including grantor trusts. It only affects the itemized
deductions of individual returns. If the individual is
being taxed from a trust, and it doesn’t have to be a
Grantor Trust, then itemized deductions net against
income and so can avoid the Pease Limitation.
• Net Investment Income Tax: Grantor trusts are not
subject to the new NII tax under the affordable care
act. Non-Grantor trusts are affected over the $11,950
of taxable income (Trusts highest tax bracket)
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accountants guide to grantor trusts 111714

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