Alternatives to Form 1041 for Grantor Trusts 

    TAX CLINIC 
    by Marvin D. Hills, CPA/PFS, CLU, ChFC, South Bend, Ind. 
    Published September 01, 2013

    Editor: Frank J. O’Connell Jr., CPA, Esq.

    Estates, Trusts & Gifts

    Normally, a trust must file Form 1041, U.S. Income Tax Return for Estates and Trusts, each calendar year. However, for most grantor trusts, filing Form 1041 is optional. Described below are alternative methods of reporting and the situations when an alternative reporting method is available. This item also addresses concerns some people have expressed about using these alternatives, particularly with irrevocable grantor trusts (where the trust assets are not includible in the grantor’s taxable estate).

    When grantor trust status applies, either the grantor or a beneficiary is treated as the owner of the activity inside the trust for income tax purposes. In that case, the deemed owner must include the activity of the trust on his or her personal tax return (see Regs. Sec. 1.671-2(a)). Grantor trust status can apply to either a revocable or an irrevocable trust, and there can be multiple deemed owners of a single trust.

    The general rule is that all grantor trusts must file a Form 1041, which contains only the trust’s name, address, and tax identification number (TIN) (see Regs. Sec. 1.671-4(a)). The assets owned by the trust are normally titled so that the earnings are initially reported by the payor (i.e., the brokerage firm, partnership, or, in many cases, an S corporation, etc.) as being taxable to the trust. However, by filing the Form 1041, the trustee is in effect letting the IRS know that the items of income or deductions are instead reportable by the “deemed owner.” The activity that is reportable by the deemed owner is summarized on a separate statement (a grantor tax information letter), which is attached to the otherwise blank Form 1041 when it is submitted to the IRS. However, there are two alternative reporting methods that allow some grantor trusts to avoid filing a Form 1041.

    First Alternative

    One alternative method allows the trustee of the trust to file Forms 1099 in lieu of a Form 1041 (see Regs. Sec. 1.671-4(b)(2)(iii)). In that case, the ownership of the assets themselves is listed in the normal way with the payor, so that income is initially reported as taxable to the trust. However, the taxability of that income is shifted to the deemed owner when the trustee prepares Forms 1099 showing the trust itself as the payor, and the deemed owner as the payee. As a practical matter, though, if there are multiple types of income (dividends, interest, rent, etc.) or multiple sale transactions, this method may not be any easier than filing a Form 1041. Furthermore, as described below, unless the deemed owner is the trustee or a co-trustee, filing Forms 1099 does not negate the trustee’s duty to prepare the grantor tax information letter and send it to the deemed owner to be reported on his or her personal return. In that situation, filing Forms 1099 involves virtually as much effort as filing Form 1041.

    Second Alternative

    The other alternative, however, is a relatively easy way to avoid filing either a Form 1041 or Forms 1099. This involves changing the way the ownership of the trust’s assets is listed with the payor. Specifically, Regs. Sec. 1.671-4(b)(2)(i)(A) is available as long as the grantor trust is treated as owned by only one person. In this scenario, the trustee furnishes to all payors of income (e.g., a brokerage firm, etc.) the following information, so that Forms 1099 or Schedules K-1 (from either a partnership, S corporation, or a trust, as the case may be) are issued using:

    • The grantor’s name;
    • The grantor’s taxpayer identification number (i.e., Social Security number (SSN)); and
    • The trustee’s address.

    In this alternative, the income is reported to the IRS as being taxable directly to the deemed owner; however, the forms are mailed by the payor to the trustee. The goal of this alternative reporting method (from the IRS’s perspective) is to have Forms 1099 and Schedules K-1 issued in a manner that allows the IRS to computer match the income directly against the income shown on the individual’s Form 1040.

    An often-mentioned concern with this technique, however, is that precise compliance with this alternative would tend to not leave a clear trail that the assets are legally owned by a trust, rather than owned individually, particularly if the trustee’s and grantor’s addresses are the same. This concern is particularly acute if the trust is irrevocable and the intent is for the assets to be outside of the grantor’s taxable estate. However, it is important to remember that this alternative method of reporting does not change the fact that the assets are legally titled in the trust’s name. It is merely changing the method for reporting the trust’s income and deductions. Nevertheless, someone who is looking solely at an S corporation Schedule K-1 upon the death of the grantor (showing the grantor’s name, SSN, and address) could mistakenly miss the fact that the actual stock certificates would clearly show ownership by the trust. In other words, this alternative method might cause the estate planning benefits of the trust to be inadvertently missed.

    For the above reason, the best solution (to both comply with the regulation and still “leave a clear trail”) is to not give to the payors just the grantor’s name alone (as suggested by the regulations), but rather to show both his or her name and the trust’s name on the payor’s records. Thus, if “John Doe” created the trust, the name section of the Form 1099 or Schedule K-1 would contain the following: “John Doe, grantor of the Doe Dynasty Trust dated 12/30/2012.”

    In this way, the Forms 1099 or Schedules K-1 would be issued in the grantor’s SSN, and the grantor’s name would be the first item in the name section, followed by a reference to the trust. This technique gives the trustee the option to avoid filing either an annual income tax return or Forms 1099. Instead, the taxable income is reported directly on the grantor’s Form 1040.

    Other Reporting Issues

    These optional methods are not available for a trust that is merely a grantor trust because of a qualified subchapter S trust (QSST) election (see Regs. Sec. 1.671-4(b)(6)(iii)). For a QSST, a Form 1041 must be filed each year.

    Also, regardless of the reporting method used (i.e., a Form 1041 or one of the alternative methods), the grantor tax information letter must be sent to each deemed owner. This step is unnecessary, however, if there is only one deemed owner who is also either the trustee or a co-trustee (compare Regs. Secs. 1.671-4(b)(2)(ii)(A), 1.671-4(b)(2)(iii)(B)(1), and 1.671-4(b)(3)(ii)(B)(1)).

    If the grantor is the trustee or a co-trustee, and the second alternative method of reporting is used, then no Form 1041, Form 1099, or separate grantor tax information letter is required. In that situation, it is important to include the name of the trust behind the deemed owner’s name so there is no confusion that the trust owns the asset.

    EditorNotes

    Frank J. O’Connell Jr. is a partner with Crowe Horwath LLP in Oak Brook, Ill.

    For additional information about these items, contact Mr. O’Connell at 630-574-1619 or frank.oconnell@crowehorwath.com.

    Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.




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