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accountants guide to grantor trusts 111714

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accountants guide to grantor trusts 111714

  1. 1. 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
  2. 2. 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. 2Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved
  3. 3. 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 Rights Reserved 3
  4. 4. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 4
  5. 5. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 5
  6. 6. Calculating Taxable Income (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 . Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 6
  7. 7. Calculating Taxable Income (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) Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 7
  8. 8. 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 Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 8
  9. 9. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 9
  10. 10. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 10
  11. 11. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 11
  12. 12. What are the Alternative Reporting Methods? • No return method • 1099 method Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 12
  13. 13. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 13
  14. 14. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 14
  15. 15. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 15
  16. 16. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 16
  17. 17. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 17
  18. 18. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 18
  19. 19. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 19
  20. 20. What happens when someone dies? (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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 20
  21. 21. What happens when someone dies? (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 Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 21
  22. 22. What happens when someone dies? (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 Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 22
  23. 23. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 23
  24. 24. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 24
  25. 25. 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.” Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 25
  26. 26. 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. Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 26
  27. 27. 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) Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved 27
  28. 28. Thank you Questions? 28Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All Rights Reserved

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