When someone dies, he often leaves at least a little money behind, whether in cash or in the form of worldly possessions. If there’s a will, money is distributed as stipulated in that will. If not, sorting it all out can be tricky. One way to make that whole process easier is to have the money shifted into an estate, where it becomes its own entity for tax purposes. Then a person appointed as successor trustee can file taxes on behalf of the estate, rather than it going through a survivor’s personal tax return.
For trusts operating on a calendar year, returns are due April 15. For trusts on a fiscal year, returns are due on the 15th day of the fourth month following the close of the tax year.
When Are Trust Tax Returns Due?
Unlike personal tax returns, trust tax returns have more than one due date. An estate administrator has the option of either setting the trust up on a calendar year, which is the same timeline followed by standard tax filers, or a fiscal year. For trusts that operate on a calendar year, tax returns are due the same date as everyone else’s: April 15.
The vast majority of trusts, though, operate on a fiscal year, based on the date the person died. If your trust is set up on a fiscal year, your tax return will be due on the 15th day of the fourth month following the close of the tax year. In other words, if your fiscal year ends on June 30, your form will be due October 15 of that same year.
Filing a Trust Tax Return
There are two forms involved in filing taxes for a trust. One is Form 1041, U.S. Income Tax Return for Estates and Trusts. Here your trustee will report the income, deductions, gains and losses for the estate in that tax year. This form will also be where they’ll report income paid to household employees after your death. If income is being held from one year to the next for future distribution to your survivors – for instance, a grandchild who won’t inherit the funds until reaching the age of 25 – it will need to be reported using Form 1041 each year.
Trustees will also use Schedule K-1 to report the beneficiary’s share of any income, deductions and credits. Your trustee will file one of these with the IRS for each beneficiary, reporting all money that was distributed from the estate. The trustee will also send a copy to each beneficiary so she can report the distribution on her own tax return.
Establishing a Trust With the IRS
If the trust is established while you’re still alive, taxes can be paid using your own tax ID until your death. But as soon as possible after taking over as trustee, a tax ID will need to be set up with the IRS. This is done through an Employer Identification Number, which works similarly to a Social Security number. The EIN will exist throughout the lifetime of the trust, and will be closed once all of the assets in the trust have been distributed and all debt has been paid. In order to apply for an EIN, the trustee will need some basic information about the trust, including the name of the trust, the type of trust, the date the trust started, the trustee’s name and the trust’s mailing address. Your trustee will also need to provide your Social Security number.
You can apply for an EIN online between 7 a.m. and 10 p.m. Eastern Standard Time, Monday through Friday. If you’d prefer to apply by mail, you’ll use Form SS-4 and either fax or mail it in. If you apply online, you’ll have your ID in a matter of minutes. The fax-in process, however, can delay receipt by several days, since the IRS will fax the number to you using the fax number you provided on the form. Mail-in requests can take at least four to five weeks, so plan in advance if this is the route you take.
Trusts After Death
If a person dies without a trust in place, one will be set up. This is called a testamentary trust. Testamentary trusts are wrapped up in a will to manage the distribution of all of the remaining funds. In your will, you’ll appoint a trustee, who will be charged with making sure the wishes stated in the will are carried out. The trustee’s role is to manage the funds until they’re all distributed, including filing taxes each year and taking care of paying any expenses associated with closing out the estate.
A testamentary trust still must go through the probate process, with the courts overseeing the distribution to make sure it’s being handled appropriately. The problem with this is that the assets in the trust will remain untouched until probate is complete. This can take one to three years, depending on the state, which means survivors will need to wait patiently for their funds.
Setting Up a Living Trust
One of the best ways to avoid probate is to set up a trust before you die. A living trust lets you set your assets up to be transferred to your loved ones after your death. The best part is that assets in a living trust don’t go through probate, which means your survivors won’t have to wait one to three years to get their distributions. You don’t need an attorney to provide the document for you. In fact, you can find templates online that you can fill out and save. However, it is important to get a notary to authorize that you signed it to avoid any issues.
When creating a living trust, you’ll need to specify the trustee, which is the person with the very important role of making sure the trust is managed once you’re gone. This should be an impartial, responsible party who will make sure your wishes are carried out. You will serve as the trustee until your death, at which point the trustee you’ve appointed will take over. You’ll also name in the trust what property will go to which of your survivors, as well as naming who will manage any assets you leave to minors.
Choosing a Trustee
Appointing a trustee will be one of the most important decisions you make. The same importance applies to the executor you choose for your will. Your chosen trustee may be a trusted friend or a family member who isn’t personally invested in what you’ll do with your assets when you die. Impartiality is important because there may be some infighting among your survivors, and if one of those survivors is the child or parent of the person you’ve chosen as a trustee, there could be accusations of favoritism. You should also make sure you choose someone who is business savvy and knows when to consult a legal professional.
If you don’t know of anyone close to you who applies, you can appoint a corporate trustee who will act on your behalf. These professionals generally have a background and expertise that puts them ahead of personal friends and relatives in their ability to oversee a trust. However, they’ll usually command a much higher fee for their time. They also have to worry about liability in every decision they make, which could slow things down at best and lead to decisions that aren’t in your family’s best interest at worst.
Trusts Versus Wills
Trusts can easily be mistaken for wills, since they both serve similar functions. This is especially true with living trusts, which are set up while you’re still around. It can help to think of a trust as a pretend lockbox, in which you store all of your money and property for distribution to your loved ones. A trust operates as a document, just as a will does, but it relates specifically to how your assets will be distributed.
So why do you need a will? There are many things your trust document won’t cover. If you have young children, for instance, it won’t name guardians for those children. It also won’t offer instruction on how debt should be paid. If you only have a will and avoid a trust, though, your funds will go through probate, whereas a living trust can help you avoid that.
Irrevocable Versus Revocable Trusts
If you decide to set up a trust before death, you’ll be faced with another decision. There are two major types of trusts: irrevocable and revocable. A revocable trust can be changed or completely withdrawn at any time after you put it in place. This gives you the comfort of knowing you have flexibility in the trust you draw up. However, there are tax repercussions to this option, since the IRS knows you can make adjustments to it at any time. This means the funds you put into a trust will still be subject to taxes as though they were sitting in your bank account.
Irrevocable trust taxes, on the other hand, are a better option for some. Once put in place, an irrevocable tax cannot easily be altered or revoked, so some find the tax benefits aren’t worth it. Complicating matters is the fact that the tax benefits of irrevocable trusts aren’t as good as they once were. At one time, heirs were taxed at a lower rate if a trust was irrevocable, but the IRS developed grantor trust rules to take care of that. However, a grantor trust means that the income is taxed at your tax rate rather than your survivors’. This can be a benefit if you’re retired and at a lower tax rate at the time of your death than your adult children, who are still working full-time.
How Long to File Taxes?
After your death, your trustee will need to keep up with the trust tax return due date for as long as money remains in the account. As long as money is still in the trust, that annual tax return will need to reflect any income it’s making. If it generates interest in a given year, in other words, the trustee will need to pay taxes out of the estate to cover the IRS bill for it. The trustee will also be able to take a deduction for the trust for any net income on assets that were distributed.
The IRS requires a form for each tax year that the trust still has assets. Once everything in the trust has been distributed, the trustee must take action to dissolve it, including filing a final trust accounting and making it available to all beneficiaries. Once the trust has been cleared out completely, the trustee will need to carefully review the trust document to make sure there are no provisions specific to closing out the trust. She’ll then write a document to all beneficiaries stating that the trust is being closed and she’s stepping aside as trustee. She’ll also then need to contact the IRS to close the tax identification number issued for the trust, which will absolve her of the obligation to continue filing taxes for that trust.
- Business Insider: Here's what happens with your stuff after you die
- IRS: Instructions for Form 1041 and Schedules A, B, G, J, and K-1
- LegalZoom: How to Set Up a Tax ID Number for a Trust Account
- IRS: Apply for an Employer Identification Number (EIN) Online
- IRS: Instructions for Form SS-4 (12/2017)
- LegalZoom: 10 Things You Should Know About a Testamentary Trust
- NOLO: Making a Living Trust: Can You Do It Yourself?
- AARP: Choose the Right Executor or Trustee
- NOLO: Living Trust v. Will
- Financial Engines: Irrevocable trusts and taxes.
- The Motley Fool: What Is the Taxation of Family Trusts?
- Pennyborn: How to Close a Trust After Administration
- Pennyborn: Why is a Trustee Required to Provide an Accounting?