With the 2021 tax season upon us, it’s time to review all of your estate planning documents, especially your trusts. The IRS requires you to file Form 1041, U.S. Income Tax Return for Estates and Trusts, for each trust that received $600 or more in income during 2021 or that has a nonresident alien as one of its beneficiaries. The only exception to this requirement is a grantor trust.
Calculating the Tax Owed
The computations for determining the amount of tax a trust owes, if any, follow the same lines as those you use when calculating credits and deductions for your personal income tax amount. As a general rule, if you cannot take a credit or deduction for something, the trust likewise cannot take one for a similar item.
Keep in mind that a trust must prepare a Schedule K-1 for all beneficiaries showing the amount of income distributed to them during the 2021 taxable year and therefore the trust credits and deductions attributable to them. Each beneficiary, in turn, attaches this schedule to his or her Form 1040 and pays the taxes thereon. The trust only pays income taxes on the amount of income not distributed to beneficiaries.
The handling of charitable contributions for tax purposes can become complicated. Whether the trust can deduct distributed funds depends on what type of trust it is. For instance, a simple trust cannot take a deduction for charitable contributions. Simple trusts share the following characteristics:
- They distribute all of their yearly income to beneficiaries.
- They cannot distribute principal.
- They cannot make distributions to charities.
In general, all other types of trusts are considered to be complex trusts and can distribute income to charities and take the deduction. As with any other type of beneficiary, the charity pays the associated taxes.
The 65 Day Rule
If you are new to trusts, you may be unaware of the 65 Day Rule. Authorized by Section 663(b) of the Internal Revenue Code, this rule is only applicable to non-grantor trusts. It allows the trustee to treat any trust distributions to a beneficiary during the first 65 days of a tax year as though they were made during the preceding tax year. Assuming your trust’s tax year ended on Dec. 31, 2021, this means that you have until Mar. 6, 2022, to make any such distribution and treat them for tax purposes as though they were made during 2021.
Given that the marginal rates kick in considerably sooner for trusts than for individuals, the 65 Day Rule may save your trust significant 2021 income taxes, for which the following marginal rates apply:
- 10% for trusts receiving income of $0 to $2,650
- 24% for trusts receiving income of $2,651 to $9,550
- 35% for trusts receiving income of $9,550 to $13,050
- 37% for trusts receiving income of $13,051 or more
One confusing aspect of the 65 Day Rule is that, while the trustee must make the distributions within the first 65 days of a tax year, he or she does not actually make the election to do so until he or she files the trust’s tax return, which is generally on April 15.
If you have questions about the tax implications of any trust you established through AmeriEstate Legal Plan, do not hesitate to contact us.