Form 1041 – Who and When to File
If you are an executor for an estate or a trustee, you may need to file a Form 1041. Otherwise known as an estate income tax or trust income tax return. Every estate and most trusts that have a gross income of $600 or more in a taxable year must file a Form 1041. Revocable living trusts and some irrevocable trusts do not have to file a Form 1041. This occurs because the trust reports the income generated against the social security number of the grantor. Therefore, the grantor’s Form 1040 (personal income tax return) will report the income.
A way to determine whether your irrevocable trust requires filing Form 1041 is to check the trust’s tax identification number. If the grantor’s social security number is the tax ID, then you most likely will not need to file a Form 1041. You’ll probably need to file a Form 1041 if the tax id of the trust is an EIN, and the trust generated enough income.
Income Tax vs. Transfer Tax
Additionally, it is important not to confuse estate income tax returns (Form 1041) with estate tax returns (Form 706). An estate income tax return (Form 1041) is an annual filing which taxes the income generated by the estate. Additionally, it is due on the same date as your individual income tax return (Form 1040). Whereas an estate tax return (Form 706) is a one-time transfer tax on the value of the assets owned by a decedent. Additionally, they are due nine months after the decedent’s date of death.
Income Tax Brackets for Trusts & Estates
The Tax Cuts and Jobs Act (“TCJA”) significantly raised the tax brackets Form 1041, which fundamentally changed prevailing estate planning techniques and strategies. The below table shows the adjusted tax rates and income brackets for the tax year of 2021.
Income Bracket | Tax Rate |
$0 to $2,650 | 10% of income over $0 |
$2,650 to $9,550 | $265 + 24% of income over $2,650 |
$9,550 to $13,050 | $1,921 + 35% of income over $9,550 |
$13,050 or more | $3,146 + 37% of income over $13,050 |
When you contrast the Form 1041 tax brackets with those for individual taxpayers in 2021, you understand the importance of avoiding Form 1041. Estate income and Trust income tax avoidance should be an important part of every estate plan. The highest tax rate for both trusts, estates and individuals is 37%. Married couples filing jointly begin being taxed at that rate for incomes over $628,300. Individuals begin being taxed at that rate for incomes over $523,600. However, trusts & estates begin being taxed at that rate for incomes over only $13,050.
Excluded Assets
It’s typically very easy to determine the assets that are taxable as a part of a trust. Assets title in the trust’s name will be reportable on the Form 1041. However, estate assets are not so easily discernable. The estate tax return won’t necessarily include every asset that a decedent owned at death.
Accounts that were titled in the decedent’s name at the time of their death and had valid beneficiary designations will not be included in the estate income tax return. This typically applies to IRAs, life insurance policies, and annuities. However, title to the asset may pass to the estate if there was no valid beneficiary designation. After which all income generated would be reportable on the Form 1041.
Accounts with transfer on death (TODs) and pay on death (PODs) designations will also pass outside of the estate. Therefore, they do report the income generated on the estate income tax return. This is most commonly seen utilized in bank and brokerage accounts.
Finally, jointly owned property with rights of survivorship will not be reportable on the Form 1041. This is because the property interest automatically transfers to the surviving joint owner upon the decedent’s death.
How to Limit your Estate & Trust Income Tax Exposure
The easiest way to limit your Form 1041 income tax exposure is to utilize a trust and have it regularly updated by an experienced estate planning attorney. Updates will need to occur whenever the tax code fundamentally changes. Typically, tax changes to estates & trusts don’t make headlines, so it’s important to regularly check in with your attorney (about once every 2-3 years) to make sure your estate plan doesn’t require any updates.
However, if it is too late to create an estate plan that will avoid Form 1041 filings, there are still other ways to reduce estate & trust income tax exposure. The easiest way, if possible, is to have the estate or trust distribute all of the income that was generated in a taxable year to the beneficiaries before the taxable year ends.
The executor or trustee will still have to file a Form 1041 for the trust or estate, but the entity will issue a Schedule K-1 for any beneficiary which received a distribution from it in the taxable year. The value of that distribution will then be taxable to the beneficiary, and the beneficiary will pay taxes on it based on their own individual tax rate rather than the rate for trusts & estates. The beneficiary’s income tax rate will almost always be lower than what the trust or estate would pay, resulting in a net benefit for all parties involved.
