Most tax practitioners would agree that filing a 1041 return for a grantor trust is redundant and is a waste of tax resources. This is especially true for a grantor trust owned by one person. After all, the income will ultimately flow down to the individual’s income tax return so what is the point of filling out a blank 1041 with a grantor letter?
Luckily, there is an exception for most grantor trusts that make filing Form 1041 optional. This article will discuss alternative reporting methods for grantor trust to avoid filing Form 1041.
What is a Grantor Trust?
Without going into too much detail, a Grantor Trust is a trust in which the grantor, the one who created the trust, retains specific power over the trust and its assets. Because the grantor retains power over the trust the IRS requires the trust’s income to be taxable to the grantor.
This can still be true in some cases where a third person, non-adverse to the grantor (i.e. the grantor’s spouse), holds an interest or control over the trust that can be attributed to the grantor.
For smart trust and estate professionals, a grantor trust can be a great estate planning tool. That’s because, although a trust may be considered a grantor trust for income tax purposes, it may nonetheless be outside of the grantor’s estate (based on the powers retained by the grantor).
General Reporting Requirement
In general, a grantor trust is ignored for income tax purposes – similar to a flow through entity. Unlike other trusts, if the entire trust is a grantor trust then the taxpayer is only required to fill in the entity information on Form 1041.
The assets held by the trust are normally titled to the trust which informs the IRS that the trust should pickup any applicable income or losses. The trust will aggregate the income and losses from those assets and report them on an attachment to Form 1041 called a grantor letter.
For example, let’s say the trust owns interest in several partnerships. The partnership K-1s will generally be in the name and EIN of the grantor trust but since the grantor trust is ignored for income tax purposes the grantor trust will file a seemingly blank 1041. By doing so the grantor trust is in effect letting the IRS know the income will be picked-up on the grantor’s income tax return.
Optional Filing Methods For Certain Grantor Type Trust
Generally, if a trust is treated as owned by one grantor, the trustee may choose between two optional reporting methods rather than filing Form 1041. A husband and wife will be treated as one grantor for proposes of these two optional methods.
The first alternative reporting method allows the trustee of the trust to file Forms 1099 in lieu of a Form 1041. In this case, the ownership of the assets themselves will be listed in the name of the trust and the trust will subsequently issue a 1099 in the name of the grantor.
This filing method works best for smaller trusts with less complex reporting requirements. However, choosing this option is equivalent to reporting applicable income and losses to a grantor on a grantor letter. There are still additional forms that will need to be filed with similar reporting requirements so choosing this option might not be any better than choosing to file a Form 1041.
The second alternative is a more direct approach which skips additional reporting requirements altogether. In this alternative the trustee will furnish the appropriate information to the relevant third parties so that the income and loss will be reported to the grantor.
In this scenario, the trustee would furnish the grantor’s information to the holders of the trust assets, i.e. brokerage firm, partnership, S corporation, or a trust, which reports income to the trust.
- Grantor’s name
- Grantor’s federal identification number (i.e. social security number)
- Grantor’s address
In this alternative the IRS will know that the items of income or loss reported from any 1099 or K-1 will be reported on the grantor’s return. Although the income and loss are issued to the grantor the actual asset is still titled to the grantor trust. This is an important distinction especially for grantor trusts which were created to be excluded from a grantor’s estate.
If the grantor is the trustee or a co-trustee, and this alternative method of reporting is used, then no Form 1041, Form 1099, or grantor information letter is required. However, in this scenario it is important to include the name of the trust behind the deemed owner’s name so there is no confusion in the proper ownership of the trust.
Consistent Reporting Required
If an alternative method is used the trustee should be consistent in their reporting. Additionally, the trustee should keep track of all assets within the trust to ensure proper estate planning is executed upon the grantor’s death.
There are additional considerations involved based on the facts and circumstances in a given scenario so it’s important to discuss making any election with a trusted tax professional.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
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