Executor & Trustee Tax Reporting

Executor & Trustee Tax Reporting

The role of an executor, trustee, or other fiduciary is an honorable position to accept. Nonetheless, the responsibilities can be overwhelming. Especially, when you’re expected, as the entity’s legal representative, to prepare and timely file all federal and state income tax returns. This is arguably one of the most important duties you’ll have as an executor or trustee. However, choosing to work with a Huntington Beach tax professional that is both knowledgeable and experienced in fiduciary returns, can make all the difference. The weight of that burden will now be shared and you will fulfill your duties with confidence.

U.S. Income Tax Return for Estates & Trusts

Estates, simple trusts, and complex trusts are all entities that report income, deductions, and other tax information on Form 1041. In California, Form CA 541 (California Fiduciary Income Tax Return) may also be required.

 

Form 1041 is required for both estates and trusts when gross income exceeds $600 but the filing deadline depends on the tax year chosen by the fiduciary. In any case, seeking the advice of a local tax professional is always a wise choice given gross income calculations and filing deadlines vary from one jurisdiction (IRS) to the next (California).

Decedent’s Estate – Form 1041

The death of a taxpayer (the decedent) often requires both Form 1040 and Form 1041 be filed for the same tax year. For California residents, the decedent’s final tax return is reported on Form 1040 and CA 540. These are the same tax forms used annually by all living U.S. taxpayers.

Secondly, the decedent’s estate may be required to report income (such as interest, dividends, and rental income) that is generated by a taxpayer’s assets following their death. An estate is a taxable entity separate from the decedent’s final tax return and all tax filings are the executor’s responsibility.


An estate is a temporary entity that exists only until all its assets are distributed to the heirs and other beneficiaries. The period of distribution is referred to as the settlement period and it cannot be prolonged for an unreasonable amount of time; commonly 1-3 years.

Simple Trust – Form 1041

When a trust document requires that all income be distributed in the tax year received, has no charitable beneficiaries, and does not distribute principal in the tax year, it’s considered a simple trust.

The trustee named in the original trust document, or most current version thereof, usually takes on the responsibility for filing all federal and state tax returns. Generally, a provision within this document permits the trustee to retain, and pay for with trust funds, any tax or other professional services needed to ensure all its tax filing obligations are met.

Complex Trust – Form 1041

Any trust not considered a simple trust is by definition a complex trust. Such as a trust with charitable beneficiaries, the ability to accumulate income, or one that is required to distribute principal.

Depending on what a trust requires, it’s possible for a complex trust to become a simple trust and vice versa. Similar to a simple trust, funds can and should be used to engage the services of a tax professional. Given the complex reporting requirements involved, it’s highly recommended a fiduciary seek out these services early-on.

Beneficiary Income – Schedule K-1 (1041)

Income paid to a beneficiary of an estate, simple trust, or complex trust is reported on Schedule K-1 (1041). In California, similar information is reported on Schedule K-1 (541). The beneficiary reports the K-1 on their individual tax return (Form 1040). Depending on the totality of circumstances, a beneficiary may be personally liable for federal and state income tax associated with the K-1.

 

A K-1 is included in the federal and state tax filings and it should be distributed to beneficiaries as well. Without a properly prepared K-1, an income beneficiary is at risk of underreporting income on their individual tax returns. This may result in them owing unexpected taxes, penalties, and interest.

GET STARTED | FIDUCIARY 4-STEP PROCESS

Step 1: Review Legal Document – Wills & Trusts

Thoroughly reviewing a decedent’s will or trust is an important first step in understanding what a fiduciary tax return will require. These important documents offer a roadmap for both the fiduciary and the tax preparer.

For instance, this is almost always the case with a revocable trust; commonly referred to as a living trust. This popular legal document is the go-to trust instrument for proactive taxpayers wanting their heirs to avoid the expense and hassle of probate. Especially, as it relates to the transfer of real estate. With a living trust, a person maintains full control over their assets while alive. Upon death, the taxpayers living trust becomes an irrevocable trust for tax purposes. The trust documents provide the fiduciary with detailed guidance on all matters related to its execution, including how and when assets should be distributed to beneficiaries.

Step 2: Request an EIN – Form SS-4

Given a decedent’s estate, simple trust, and complex trust are separate entities, they require a federal employer identification number; or EIN for short. An EIN, which most businesses have as well, is similar to a social security number (SSN) for individuals.

 

To request an EIN from the IRS, Form SS-4 must be properly prepared and submitted to the IRS either by mail or online. Even when an EIN is requested online, the IRS requires Form SS-4 be prepared, signed, and kept on file by the representative submitting the application.

Step 3: Notify the IRS – Form 56

An executor, trustee, or other fiduciary should formally notify the IRS that they are the entity’s representative. This ensures all notices, bills, and other correspondence are sent to the person in charge. It also allows the IRS to discuss tax matters pertaining to the entity directly with the fiduciary and for the fiduciary to execute a power of attorney with the IRS (Form 2848); thereby allowing other representatives, such as a tax accountant, to be formally involved in the process.

Step 4: Prepare Tax Returns – Form 1041 & CA 541

After the legal documents have been reviewed, an EIN has been obtained, and the IRS is notified about the fiduciary, the process of preparing required federal and state tax returns begins. Generally, all tax statements reporting income, deductions, or credits will need to be collected and provided to the accountant preparing the returns. Providing detailed information and answering tax related questions, as well as signing a service agreement, are all part of the tax preparation process. In many ways, it’s no different than having one’s individual tax return professional professionally each tax season.

After the tax returns have been prepared then reviewed by the fiduciary, they are ready to be submitted electronically (e-file). Once accepted, the fiduciary should pay any federal or state tax due and distribute a K-1 to all income beneficiaries. It’s important that filing deadlines are met and taxes are paid on time. This will avoid any unnecessary penalties and interest imposed by tax authorities.

For more information on fees and services for preparing Form 1040, see Income Tax: Individuals

 


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