The creator of a revocable trust, legally called the “grantor,” has the right to change, amend or revoke – do away with – the trust at any time. Also known as a grantor trust, the income earned on the trust is apportioned to the grantor while living. The grantor must then report any income, dividends, deductions and gains on their own personal income tax return. The beneficiaries of a revocable trust have no tax responsibility upon receiving income distributions at the death of the grantor. Grantors of a revocable trust are personally responsible for listing the income from the trust on personal income tax returns, and for paying any applicable taxes while living, the beneficiaries are not liable. Understanding these grantor trust tax return filing requirements is absolutely essential for all parties involved.
If the grantor of a revocable trust earns income from the sale of assets in a revocable trust during the year, they will be required to report these earnings as part of their personal income tax return. Once the grantor dies, the trust is converted into an irrevocable trust, at which point tax regulations change significantly.
Claiming Your Rights in a Revocable Trust
A revocable trust is a legal container that holds the grantor's assets while he's still living and passes them to beneficiaries at his death. The grantor of the trust is assigned a revocable living trust tax ID number. The grantor has complete control over the revocable trust while living and can change it at any time. Once he dies, the property or assets transfer to the beneficiary. So, the Internal Revenue Service considers the ownership of the assets in the trust to be the grantor's as long as he is alive. This means the grantor files taxes on his Form 1040 for any gains.
Deductions and Taxation Responsibilities
Revocable trusts become irrevocable, or unchangeable, when the grantor dies. If you're the beneficiary of a previously revocable trust, the tax responsibility for any income, gains or assets of the trust falls on you now that the trust is irrevocable. However, the trust pays taxes only on income it does not distribute and that is kept in the trust. If all the income is distributed to the beneficiaries, the trust claims a deduction and the beneficiaries must report and pay personal income tax on their individual tax returns. All the beneficiaries will receive a K-1 form from the trust reporting the amount of income distributed to them. The trust also includes any K-1s when it files its tax return.
Filing Form 1041
If the gross income from the trust is $600 or more during a given tax year, then the trust must file a survivor trust tax return. Any income or assets that stay within the trust, and are not distributed, will be listed on Form 1041, U.S. Income Tax Return for Estates and Trusts. You can find this form with instructions on the irs.gov site, but you should seek professional help if you have to fill it out. Typically, this task falls to the successor trustee, who is charged with taking over the trust once the grantor dies. The trustee distributes the assets in the trust according to the guidelines set forth in the trust. Once this is done, and all assets in said trust are distributed, the trust ceases to be. However, this can take years based on how the trustee is instructed to distribute income or assets to the beneficiaries. The trust may also appoint a custodian to manage income distributed to beneficiaries who are minors.
Each beneficiary receives a copy of Form K-1 and uses it to report income distributions on her 1040, as well as attaching Schedule E, Supplemental Income and Loss form. The beneficiary pays taxes at her tax rate. Bear in mind, if the income from the trust is significant, it can bump the beneficiary into a higher tax bracket. Most tax advisers recommend using a professional tax preparer, especially if the beneficiary has never completed this type of tax return.
- Internal Revenue Service: Schedule E (Form 1040), Supplemental Income and Loss
- nolo.com: What Happens When a Grantor Dies - An Overview
- LegalBeagle: Tax Treatment of Living Trust Distributions
- TurboTax®: What is a Schedule K-1 Form 1041: Estates and Trusts?
- IRS.gov. "Basic Trust Law." Accessed Aug. 29, 2020.
- IRS. "Tax Forms and Instructions, Tax Rate Tables," Page 10. Accessed Aug. 30, 2020.
- IRS. "IRS provides tax inflation adjustments for tax year 2020." Accessed Aug. 30, 2020.
Chris Brantley began writing professionally for a financial analysis firm in 1997. From 2000 to 2004, he worked as a financial advisor, specializing in retirement planning and earned his Series 7, Series 66 and insurance licenses. Brantley started his full-time writing career in 2012 and has written for a variety of financial websites, including insurance, real estate, loan and investment sites. He holds a Bachelor of Arts in English from the University of Georgia.