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Author: Ritey One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121565  
Subject: Grantor Trust Reporting Requirements Date: 3/2/2011 9:00 PM
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Last year, my family established an irrevocable grantor trust with me as the trustee. As it was explained to us by our attorney, the trust will assume no tax burden of its own if it pays out 100% of all income distributions and profits from sale of securities to the beneficiaries, or to the grantor, who may benefit from such distributions but not from the principal establishing the trust. It will then be the grantor's and/or beneficiaries' responsibilities to report any income paid out by the trust to their own individual names. Fair enough. None of us have a problem with that -- paying a slight amount of "juice" on what will turn out to be essentially found money.

I invested the trust's assets in dividend-producing stocks and income-producing unit investment trusts, requested that these distributions be paid in cash, and that checks for these investment distributions get cut monthly from the investment account in the trust's name. I've established a trust bank account to receive these assets and to disburse the money to the beneficiaries and/or grantor by check according to need, or whim, or rotation, or what-have-you. The record of bank checks and statements will serve as an additional aid to remind me of who got paid what, and to ensure the money was properly received.

I've created a goose that lays golden eggs! I'm receiving monthly checks in decent amounts from dividend and other income distributions the investments chosen have generated. Each check I receive from my brokerage account in the trust's name gets dutifully deposited into the bank account, and each month I write checks to the happy beneficiaries/grantor.

Here's where my questions begin: I'm getting conflicting messages about the trust's reporting burden for all this income. Some tax advisors (okay, mostly pundits from a leading tax preparation site's message boards) state that I must generate 1099s from the trust to each recipient of the trust's disbursements. Other advisors (from a well-known tax preparation service, no less) say that I must complete a K-1 for each recipient for much the same purpose. Still others (Just a personal friend who happens to be a CPA) say I need do nothing with the trust, and the recipients are responsible for reporting the extra income on their Forms 1040, but there seems no provision for reporting income on a 1040 that isn't derived from some official report of the income sent by the payor, such as a W-2, 1099, K-1, etc. There appears to be no way to report extraneous income -- the horse with the clock in its stomach, the prize from the fat man's race, the skinny chicken, the all-night poker game, the two dollars found floating by in the sewer, or the newly-created trust disbursement windfall -- unless reporting forms were given to the recipients.

So what's the story? Does the trust have to conjure up some document to give to the recipients to prove to the IRS its complete disbursement of the distributions to the beneficiaries, and for the IRS to cross-check against the beneficiaries' returns that the money was reported by them? Is there some sort of "honor system" in place where that money is generated somehow, some way, and is accounted for by magical means that only the IRS can reconcile between us?

Second, to keep things simple, let's state that the trust started with $100,000.00 in principal. Stock XYZ pays a $.50 dividend and the trust owns 10,000 shares it bought at $10.00/share. XYZ paid quarterly dividends of $1,250.00 which I paid out in equal sums to each of three beneficiaries and to the grantor. XYZ had some bad news announced and finished the year worth only $9.00/share, for a principal value of the trust of $90,000.00. The question is: Since the trust lost market value on paper, do those dividends now act as having cannibalized the principal, rendering the grantor ineligible to receive them until the account once again appreciates in value; or are the two events independent of each other -- one is an income-producing event independent of an unrealized capital loss -- and the grantor is eligible to take the income?

Similarly, suppose the trust were to sell those shares of XYZ and realize the $10,000.00 loss, then subsequently purchase 10,000 shares of ZYX at $9.00/share (establishing a new and current $90,000.00 principal base). If those shares of ZYX were to appreciate to $11.00/share and were subsequently sold by the trust at $11.00 per (for a total of $110,000.00), will the grantor be eligible to receive all $20,000.00 in gains as a distribution payment, or will the grantor only be eilgible to receive $10,000.00 as part of the proceeds will be drawn against the previous loss caused by the sale of XYZ, restoring the principal value of the trust to $100,000.00?

Many, many thanks for your thoughts and opinions.
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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112540 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/2/2011 9:28 PM
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An irrevocable trust is a separate tax-paying entity. As such, it will have to file a tax return and potentially pay income taxes. A trust will file Form 1041.

However, since the trust is paying out all of it's income to the beneficiaries, the trust will almost certainly pass it's taxable income through to the beneficiaries. And it does that on a K-1. You'll attach the K-1s to the trust return to support the deduction for income distributed to beneficiaries. And you'll provide each beneficiary with their individual K-1 so they can report their portion of the taxable income.

Large, nationwide tax preparation firms are highly likely to be unqualified to do this kind of tax work. You need a CPA or EA who has experience working with trusts. Lots of trusts. If they don't do at least a dozen or more each year, move on and keep looking. Unfortunately for you, these qualified people are not cheap, and can be fairly pricey. Such is the cost of setting up a trust like this.

The pundits who mention issuing a 1099 to the beneficiaries are idiots and should be ignored in full. They clearly don't know when they're in over their heads. And anything you get from internet message boards is equally suspect. (Did I just condemn my own advice??)

On your second question - the change in value of the trust's assets. Nothing is reportable until the assets are sold and the gain or loss is realized. Then that gain or loss is a capital item, very similar to capital gains and losses on your personal return. These gains/losses might be retained in the trust. Or they might be paid out to the beneficiaries. You'll have to read the trust document to see what to do with those. If they are retained in the trust, the trust will pay the tax on that income.

The trust will also need to apply for a Federal Employer ID Number (or FEIN). Yes, I know the trust does not have employees. That's just what the number is called. You will use that number much like you use your social security number. Give it to the broker who holds the trust assets so they can issue a 1099 to the trust. Give it to the bank who holds the trust's checking account. Put it on the trust's income tax return. DO NOT use your own social security number on any account holding the trust's assets.

Your state probably has laws regarding how the income and principal (sometimes called "corpus") of the trust are treated. The trust document itself is your first source of authority, but any place it's silent, your state laws will control. So you may need to consult an attorney on a regular basis.

You'll also want to pay a well-qualified person to prepare the trust's tax returns, and potentially to prepare an accounting of the trust's assets, receipts and disbursements.

There's lots of things going on with a trust. I hope you knew what you were getting into.

--Peter

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112542 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/2/2011 10:59 PM
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There appears to be no way to report extraneous income -- the horse with the clock in its stomach, the prize from the fat man's race, the skinny chicken, the all-night poker game, the two dollars found floating by in the sewer, or the newly-created trust disbursement windfall -- unless reporting forms were given to the recipients.

After you've followed Peter's excellent advice take a look at line 21 of the 1040. Software--and people who rely on it--may have trouble dealing with income that's not on an information return, but the IRS doesn't.

Back to Peter's response, get cracking on that EIN. You can get one online at www.irs.gov but you really need to know what you're doing, so you may want to make that your accountant's first task. You didn't mention when this started, but I hope it was 2011 because I'm worried that there are some reporting problems for 2010, depending on what ID number was used on the trust's accounts.

Come to think of it, how did you manage to open trust accounts without an EIN? Do tend to this seemingly trivial detail quickly and make sure those accounts are titled properly.

Phil
Rule Your Retirement Home Fool

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Author: Ritey One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112543 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/2/2011 11:49 PM
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Thanks for your easy-to-understand reply!

The taxpayer identification number was filed-for by the attorney who established the trust. The trust also holds other assets that will be apportioned upon the death of the grantor.

The trust was established for the same reason as I've seen many such trusts established: To ensure that those the grantor wants to have advantage of the funds can enjoy them without the petty squabbles or legal warfare that ensues from marginalized relatives or gold-digging strangers upon the grantor's passing. The beneficiaries don't have to worry about distant, never-heard-from-before relatives or seductive suitors creating legal havoc claiming rights to these funds just because of some convenient bond they've created to them. If they're not listed in the trust document by name or by association, they're eligible for nothing.

It isn't much cash in the grand scheme of things. The beneficiaries will still have to work for a living even after the trust is fully distributed to them in the future. The grantor has no worries about liquidity after establishing the trust with a sum of money. This money was otherwise sitting dormant in a combination of the grantor's passbook savings accounts and marginally performing mutual fund accounts before I changed its mission into an income-generating engine for the benefit of the beneficiaries and/or the grantor while hoping to maintain the principal. The income generated is used just to make the beneficiaries and the grantor all a bit happier now when they can use the cash to enrich their lives rather than as a morbid reminder of the grantor post-mortem.

From what I'm seeing, while the trust itself may be a complex legal matter, the activities of this trust will be pretty straight-forward:

Receive assets from the grantor as deemed appropriate by the grantor.
Have assets managed by trustee (me). Hope I am competent enough not to lose the whole shebang.
Have assets generate income or profits to be disbursed in full to beneficiaries and/or grantor.
Have trust generate reporting sheets (K-1s) through its reporting vehicle (1041) to the beneficiaries/grantor as paid.
Have beneficiaries/grantor report receipt of these distributed funds on their Forms 1040.

These seem like straight-forward, bite-sized missions that require maybe a good afternoon of review and understanding before accomplishing myself. How involved can it be to file a 1041 and write out three or four K-1s showing the trust generated $5,000.00 in distributable income with approximately $1,250.00 paid to each beneficiary and the grantor (as my example in the original post illustrated), address the K-1s to the beneficiaries and grantor, and the 1041 to the IRS with a copy of each K-1?

I don't mean to scoff at the level of expertise one must attain to be able to handle these matters as second nature and in a professional manner, but we are seriously talking about penny-ante amounts here not too far off from my example illustration, and from what you're telling me, hiring such a specialist tax advisor to handle such a small and straightforward account may seem like overkill to me and an insult to the specialist's expertise.

Can a do-it-yourselfer dope it out (emphasis on "dope") with some brute force, patience, and meticulous recordkeeping? I'm pretty good with step-by-step instructions and you seem to have pointed me well on the path of the right direction. All that I need now is access to the forms, and I can handle concepts like, "Enter amount distributed on Line 1 . . . Enter Name of First Beneficiary on Line 2 . . ." etc.

Thanks again for your extremely helpful reply.

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Author: Wradical Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112544 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/2/2011 11:54 PM
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The pundits who mention issuing a 1099 to the beneficiaries are idiots and should be ignored in full. They clearly don't know when they're in over their heads. And anything you get from internet message boards is equally suspect. (Did I just condemn my own advice??)
======================================
Well, sort of.

Actually, the 1099 reporting mechanism is part of one of the ways of reporting for a grantor trust. I don't have it handy, but the 1041 instructions spell out 3 different ways for reporting income to the grantor/beneficiaries of a grantor trust; and under at least one scenario they do get 1099s.

Where the grantor and trustee are one and the same, you can get by with just a Social Security number, but that's not the case here. So you're right. The trust needs to have its own ID number.

But since this is described as a grantor trust, which I'll assume to be correct, and probably due to some technical reserved power to substitute corpus or something, the beneficiaries shouldn't get K-1s, either. They should get 1099s and/or your basic "Grantor Information Letter" which most software packages produce, and isn't all that different from a K-1.

And I would suggest that this kind of a family trust might be better structured as a partnership, for simplicity, but that's another matter.

Bill

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Author: Ritey One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112545 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/3/2011 12:20 AM
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After you've followed Peter's excellent advice take a look at line 21 of the 1040.

So if Line 21 is used as a catch-all for any income you wish to declare, can't the beneficiaries just put down "$1,250.00" without any explanation on that line about how the money was obtained and leave it at that? What should the IRS care if the money was obtained as the value of a novelty gift or as a payout from an income-generating trust as long as it gets its pound of flesh?

The bone of contention is that if the income is reportable on Form 1040 without the need for a reporting vehicle such as a K-1 or otherwise, and the trust has no reporting burden as it distributed all income as instructed, then why bother with the K-1 and 1041? Shouldn't "No reporting requirement" mean just that, and leave it to the beneficiaries to declare their gains?

I established a separate bank account in the trust's name specifically to keep record of all the distributions the trust made from the investment account versus the money I paid out to the beneficiaries. If I deposited (again, using my original illustration) $5,000.00 in checks drafted from the investment account into the bank account, and then cut $1,250.00 to each of Beneficiary A, Beneficiary B, Beneficiary C, and Grantor G, couldn't the combination of the check stubs from the investment account, and the copies of the cancelled checks/bank statements showing the money was properly distributed be a satisfactory record if the IRS comes knocking on the trust's door to wonder why Tax ID AB-CDEFGHI hasn't generated any reportable income to it last year, or any?

I'm trying to make the 1041 and K-1 forms superfluous given the relative simplicity of the trust's mission and dealings. I'm hoping that Line 21 can now be used as a form of "escape hatch" putting the burden of reporting on the beneficiaries/grantor (where it should belong as they received the money), and not on the trust, which seems to open a whole world of complexity I just cannot seem to justify.

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112546 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/3/2011 1:42 AM
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But since this is described as a grantor trust, which I'll assume to be correct, and probably due to some technical reserved power to substitute corpus or something, the beneficiaries shouldn't get K-1s, either. They should get 1099s and/or your basic "Grantor Information Letter" which most software packages produce, and isn't all that different from a K-1.

Except that the OP called it an irrevocable grantor trust. And that the income was going to be paid to both the grantor and other beneficiaries. I thought a grantor trust was a trust where the current income went solely back to the grantor. And they aren't irrevocable. BWDIK?

Like I said - take most of the information you get from internet message boards with a good dose of salt. Because I still might be wrong - I certainly haven't seen everything out there.

--Peter

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112547 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/3/2011 1:45 AM
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Can a do-it-yourselfer dope it out (emphasis on "dope") with some brute force, patience, and meticulous recordkeeping?

To be honest, that is possible. Yes.

But I'd highly recommend you get a good pro to do the first return. Get everything set up correctly and then copy his/her work and dope things out in the future.

Someone shelled out good money to set up the trust. Do you want to screw things up by making tax mistakes right out of the box?

--Peter

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112548 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/3/2011 5:07 AM
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So if Line 21 is used as a catch-all for any income you wish to declare, can't the beneficiaries just put down "$1,250.00" without any explanation on that line about how the money was obtained and leave it at that?

Oh, line 21 wants more than a number. But there are two big problems with this approach. The beneficiaries would lose the preferred tax rate on qualified dividends and long-term cap gains, and the IRS would be bugging the trust for a return since that's the number the income has been reported to them under.

Phil
Rule Your Retirement Home Foo

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Author: edcosoft Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 112556 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 3/3/2011 8:39 PM
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The various types of income are collected and accounted for on the 1041. The distributions on K-1s state the type of income the beneficiary receives. Read page 2 of K-1 for 1041 which generally tell you what line of your 1041 to put eeach item. Virtually none is reportable on line 21, but mostly on line 8 aned 9 a and b and the remainder on a Schedulue E ending up on your 1040 line 17.

What you are doing, distibuting income to several people, requires an irrevocable Grantor trust, a 1041 and K-1s. A normal revocable Grantor trust requires none of these but can only pay the income to the grantor UNTIL the grantor dies and it then becomes irrevocable but no longer considered a Grantor trust.

The bookkeeping is as easy as you imply until you get into allocating expenses and accounting for Capital loss Carryovers, distribution of capital, retaining earnings. etc where you WILL need help, but until then read 1041 instructions and Pub # (can't remember the number) for Fiduciaries.
ed

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Author: Ritey One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 113375 of 121565
Subject: Re: Grantor Trust Reporting Requirements Date: 5/6/2011 10:14 PM
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Thanks, everybody, for your input into this matter.

I know it's a bit late but I was busy putting into action what has been suggested here, as well as with a friend of mine who just happened to start processing trust returns for his firm this year and gave me a bit better an idea of what to expect.

Anyway, it turns out that I have a "COMPLEX" trust and not a grantor trust, despite the relative simplicity of the terms. Apparently "complex" is a form of tax management and not a testament to any background bickering over the document itself, but there it is.

Turbo Tax Commercial allowed me to plug in all the information I needed to prepare the return for the trust, and the tax manuals associated with the software allowed me to determine how the trust is taxed on any undistributed gains.

Since this past year was a "short year" as the trust was established in 2010, the filing was straightforward, but going forward, I will have to be hawkish about the financial dealings I make on behalf of the trust and the trustees, while Turbo Tax spits out the necessary forms to file.

Once again, thank you all for your assistance. You saved me from near crisis.

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