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Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
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Experience:  Extensive Experience with Tax, Financial & Estate Issues
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Viney trust tax filing and k1 distributions, My wifes last

Customer Question

viney trust tax filing and k1 distributions
JA: Thanks. Can you give me any more details about your issue?
Customer: My wifes last parent passed away early 2015 who had a revocable trust and became irrevocable upon death.We had the whole probate extra done and assets were below IRS limit for inheritance tax so I now we are doing a trust tax and K1 distributions. Below is an example of income and principal amount of the trust.Trust income was from rental: $40K,For example principal from inheritance was $210K came from banks, life insurance etcthis year amount we distributed $200K out of which $10K was from the rental income.I know principal including life insurance should be "pass through" no taxes to be paid by beneficiaries but rest is taxableMy two questions are:1) how do I differentiate the principal asset and trust rental income in K1? Which lines do I state what? Is it tier 1 & 2 distribution?2)How do I list the principal assets in 1040? I am using Turbo tax business 2015,if you tell me what lines that would be good too.
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Submitted: 7 months ago.
Category: Tax
Expert:  Stephen G. replied 7 months ago.

OK, first of all, what you are attempting to do, ie. prepare a fiduciary income tax return, is a very difficult exercise if you do not have any experience with fiduciary accounting and tax issues. The best advice I can give you, is to engage a CPA or EA to prepare the fiduciary return for the Trust. There are a number of issues and areas that become complex very quickly and unless you know what you are doing, the chances of running into problems, that ultimately will cost additional tax, penalties & interest are more likely than not.

That said, I can assist you here, but this site is designed to answer specific questions, not to walk someone through the complete tax preparation process. So, if you want to continue with that in mind, let me respond to your first couple of questions & you can decide for yourself how you wish to proceed.

Here are a few of the things we need to know:

Was this a joint revocable trust, or did the trust originate with the decedent's spouse and was it split into two trusts when the decedent's spouse died?

The decedent's date of death & state of residence.

The number of beneficiaries of the trust and states of residence.

Is the succeeding Trustee(s) resident in the same state as the decedent?

Prior to the decedent's death, was the trust's income reported directly on the decedent's personal income tax return and was the tax reporting of the trust's assets under the decedent's social security number?

Now, first with respect to the rental property:

Note that no matter what was distributed, income or principal, for purposes of the "Income Distribution Deduction" on Schedule B, it doesn't matter whether it was income or principal, if either income or principal was distributed, all of the income is passed through to the beneficiaries; in the example you gave, that's all 40K. That goes to your question of differentiating between income & principal on the 1041 - Schedule B and the K-1; the point is you don't differentiate; not good news if you were thinking that the beneficiaries would only be taxed on 10K not 40K.

Another question; I presume the assets generating the rental income was or is in the Trust? If so, did you adjust the tax basis to the fair market value (fmv) at the date of death, allocate the fmv between land & building & recompute the depreciation for the tax year you are preparing the return for? If so, that must be done as depreciation is "allowed or allowable" & if the depreciation isn't taken, then the tax basis is reduced anyway & if the property is sold, the gain is increased with no current benefit of the depreciation not claimed.

I'm not sure what you mean by "How do I list the principal assets in 1040?". Do you mean the 1041 or the 1040?

What specific assets are you referring to?

I'm sure you will have some additional questions or require clarification of something I've "said", so please let me know. Again, I'll do what I can to assist you, but I can't do the return for you; that's not permitted under IRS regulations, unless I am the actual Preparer and sign the return, a service that I am not providing here.

Steve G.

Customer: replied 7 months ago.
Thank you so much for your guidance.Let me address your questions first, and hope this helps. It was always a joint revocable trust per the will that was drafted prior to both of my wife's parents deaths. Her mother passed October 19, 2004, and father on April 5, 2015. Her father lived in TX. There are three beneficiaries, my wife, who also lives in TX, and her two sisters, one who resides in New Mexico, and one who resides in Canada. The Canadian one has dual citizenship. All three sisters are the sole beneficiaries and all three are trustees, but only my wife resides in TX. Prior to decedent's death there was never a tax filed for the trust, everything was done on his individual tax.Also, further down in your response you asked if the rental income is in the trust, and to answer your question, part of it is in the trust, and part of it has been distributed. I will make sure to adjust the tax basis to the fair market value (fmv) at the date of death, allocate the fmv between land & building & recompute the depreciation for the tax year we are preparing the return for. You also said in your response, "I'm not sure what you mean by 'How do I list the principal assets in 1040?'. Do you mean the 1041 or the 1040? What specific assets are you referring to?" I meant 1041. Here, I am referring to referring to distributions that were already taxed when you say principal assets(For e.g money in has savings accounts)I am a little bit confused on your K-1 guidance as we have received what seems to be some conflicting guidance from my wife's probate attorney, who, like you is apt at understanding taxes with trusts. I do not want to miscommunicate anything provided by the attorney, so I am pasting the verbatim guidance below. Is there a disconnect here or is this inline with what you are saying, as he is saying we do not pay taxes on any principal distributions (ones that have already been taxed)? See below:'For the 2015 income tax return for the Trust, only the 2015 “net” income that was actually distributed out to the three beneficiaries should be reported on K-1 to each where each would then report that income on her personal income tax return. If any net income is retained by the Trust, then the Trust would be the one that has to pay income tax on the net income, if any, held back in the Trust.For any 2015 distributions of principal from the Trust, that is funds that have already been taxed, there should be NO income tax consequences to the beneficiaries for receiving distributions of principal from the Trust. Typically on the K-1 there is place for “distributions” and you would report those principal distributions there, and the distribution made in 2015 will be made up of both income and principal. If for whatever reason you cannot get this to work in TurboTax (but you should be able to get it to work as I have worked on a Trust before just like this and TurboTax was used), then you can just report the “net” income distributed out to the beneficiaries on a K-1. The key here is that you just need to make sure all net income generated is accounted for, whether that by having all beneficiaries report the income (assuming all net income was distributed out), or by having the Trust and the beneficiaries report and pay income on the income received (assuming only a portion of net income was distributed out and Trust retained remaining net income).'
Expert:  Stephen G. replied 7 months ago.

Not exactly a disconnect, but first of all if you were dealing with a Joint Living Trust, why was there a Probate Process? What assets were "probated"?

As I said, I really don't think you are going to be able to do the 1041 properly.

You aren't being taxed on any principal; it's simply that the principal distributions are used to pass through the income; you don't want to get involved with the "throwback rules" relating to accumulated income & tax rate adjustments.

First, you must define the Trust:

From the 1041 Instructions:

Simple Trust
A trust may qualify as a simple trust if:
1. The trust instrument requires that
all income must be distributed currently; (Not being done?)

2. The trust instrument doesn't
provide that any amounts are to be paid,
permanently set aside, or used for
charitable purposes; and
3. The trust doesn't distribute
amounts allocated to the corpus of the
trust. (Is being done?)
Complex Trust
A complex trust is any trust that doesn't
qualify as a simple trust as explained

First, if you are accumulating income as you said (30k of rental income) (you are now dealing with a complex trust); so line 10 applies.

Line 10—Other Amounts Paid, Credited, or Otherwise Required To Be Distributed
Line 10 is to be completed only by a decedent's estate or complex trust. These distributions consist of any other amounts paid, credited, or required to be distributed and are referred to as second tier distributions. Such amounts include annuities to the extent not paid out of income, mandatory and discretionary distributions of corpus, and distributions of property in kind.

When I said I would assist you, I didn't mean all under one question; this is a very busy time of the year & I really can't afford to bounce around; we try to answer questions as they arise as well as any follow-up questions on the same topic, so please keep that in mind; what you are asking here is not questions about your particular filing these are basic issues relating to preparation of Trusts tax returns.

Expert:  Stephen G. replied 7 months ago.


Perhaps your "Probate Attorney" hasn't done any fiduciary income tax returns for awhile; there's no reporting of principal distributions on the K-1s; I think he may be mixing up Simple Trusts & Complex Trusts as most attorneys don't really get involved in income tax reporting; you never really want to accumulate income, so his advice in that area would be questionable; the definition of Simple verses Complex is quite specific as you can see; trusts routinely flip flop from Complex to Simple & vice versa usually until the Trustee figures out that the Trust income tax brackets normally result in a lot higher tax on the income and if income is accumulated, the effect is negated anyway because the trust accounting & taxes become much more complicated without any benefit; just read the "Throwback Rules" in the 1041 instructions. Based upon what you did, you can avoid all that simply by including the distributions on line 10 and switching the Trust to a simple trust for 2016; it's best to terminate the Trust as soon as possible; that's the normal course of events for this type of Trust Arrangement; it's primary purpose is to avoid Probate; once the Grantor dies; it gets expensive to keep the Trust around & there's no reason to do it; the assets in the Trust are not subject to Probate claims, which are generally nil for most people.

I'd appreciate it if you would rate my response, as that is the only way we receive credit for our work. I think I've been pretty generous with my time and knowledge.

Steve G.

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