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Lev
Lev, Tax Advisor
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Where is Special Needs Trust reported on Form 1041?

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I am filing a Form 1041 for a special needs trust. It has $300 in interest income for the year and two checks were written for medical expenses. Does the $300 interest go on a K-1 to the beneficiary? Do the medical expenses paid need to be reported somewhere?

As a trustee - you are in charge for the trust and if the trust has any income - either distributed or not - you should file trust income tax return - form 1041 - http://www.irs.gov/pub/irs-pdf/f1041.pdf

and report distributed income to beneficiaries on schedule K-1 - http://www.irs.gov/pub/irs-pdf/f1041sk1.pdf

according to instructions - http://www.irs.gov/pub/irs-pdf/i1041.pdf page 3

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has:
1. Any taxable income for the tax year,
2. Gross income of $600 or more (regardless of taxable income), or
3. A beneficiary who is a nonresident alien.

As long as trust's income is distributed - it is taxable on each beneficiary tax return and not taxable on the trust tax return. Medical expenses paid by the trust on behalf of beneficiary deemed distribution. You may report that information in the box 14 with the code H and may add a separate sheet with details.

There will be two option from tax prospective:

  • the income will be distributed from the trust within tax year - that income will be taxable for recipient
  • the income will not be distributed from the trust within tax year - that income will be taxable for trust.

Usually individual tax rate is more beneficial, but that depend on other circumstances as well.

Customer: replied 8 years ago.

Okay - I am still a little unclear. The trust was started in 2007. It had interest income of $300 and expenses of $1,700. In addition, $42,000 was put into trust in cash. I think I need to report the $300 on Form 1041 line 1 and report the $1,700 in medical expenses on Schedule B, line 10 of Form 1041. The $300 income will then pass through on a K-1 to the beneficiary's tax return. The $42,000 contributed to the trust in cash does not get reported on the return as far as I can tell. Is all of that correct? Thanks.

On Schedule B, line 10 of Form 1041 you would report distribution that may be deducted from taxable income - as medical expenses are not deductible for the trust - you should not report that amount. You will report only distributed income - that is $300; The same amount will be reported on the K-1. Other distribution was not from income but from trust assets - that are not reported on the trust income tax return nor may reduce tax liability.

But you may report that information in the box 14 with the code H and may add a separate sheet with details - so beneficiary would know the source and type of distribution. for instance - in your situation - medical expenses may be deductible for beneficiary.

Customer: replied 8 years ago.

Okay - I am getting there. I think this is very simple in the end. One more question so that I fully understand. Why is the $300 considered distributed income if the medical expenses were considered as paid from trust assets? Those were the only expenses paid out of the trust. The $300 stayed in the trust bank account. I will have a pro do this next year but for this year I just want to understand how it works! I will accept after this reply so that you can get paid. Thanks for all your great help!

Medical expenses paid on behalf of beneficiary deemed distribution - thus the beneficiary received of $1,700.

Then - what is the source of that money? - $300 is distributed income and $1400 form trust's assets. Thus $300 will be reported on the schedule K-1 and deducted on the trust income tax return and reported on the beneficiary's income tax return.

Usually individual tax rate is more beneficial than one the trust would pay. However generally - you may treat this income taxable for trust and do not need to issue K-1 for beneficiary. You likely will have more taxes on that income.

I think after you complete all these paperwork - you will be a pro.

Lev and other Tax Specialists are ready to help you

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