Do Revocable Trusts Have to File a Federal Income Tax Return?

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Many people set up revocable trusts to take care of their financial needs at the end of life and to serve as a conduit for assets when they pass away. Trusts are unique because they are separate legal entities from the grantors who set them up, and may pay their own taxes at certain points in their life cycles.

Grantor Trusts

  • Nearly all revocable trusts are grantor trusts for purposes of taxes. This means that the person who set up the trust retains control of the assets and trust income. In these cases, the IRS sees the trust as an extension of the grantor -- because she can change the terms of the trust at any time, as well as removing and depositing assets at will. When it comes to paying taxes, it's as if the trust doesn't exist -- it is invisible and the grantor reports all trust income on her own tax return.

Paying the Tax

  • When April 15 rolls around, grantors should include trust income, expenses and losses with their own income and expenses for tax purposes. Practically speaking, this means filling out your IRS Form 1040 as if you had never set up the trust at all. There is no need to differentiate between trust income and personal income for the purposes of this form. Be aware that if you make significant income from your trust during the year, you may need to pay additional tax during the year as well. This means increasing any payroll withholding you have or making quarterly estimated tax payments if you will owe more than $1,000 in additional tax due to trust income.

Death of the Grantor

  • When the grantor of a revocable trust dies, the trust undergoes a slight transformation from revocable to irrevocable. There is nothing that must be done to effect this change, it happens automatically because the grantor can no longer make changes. When this happens, the tax situation also changes. The trustee should apply for a tax identification number for the trust, and file a Form 1041 tax return for the trust on an annual basis. Most irrevocable personal trusts are "pass-through" trusts, that is, trust beneficiaries pay tax on the income they withdraw during the year, and the trust pays tax on any that remains. The same estimated income tax rules apply for irrevocable trusts as for revocable trusts -- if more than $1,000 in tax will be owed at the end of the year, the trustee should make quarterly estimated payments to the IRS.

Tax Evasion Schemes

  • Unscrupulous estate planners sometimes suggest that individuals can avoid paying tax on income at all by placing assets into a revocable or irrevocable trust. This is almost always incorrect, and qualifies as tax evasion. If someone makes promises that sound too good to be true, you may be party to an abusive trust tax evasion scheme. If you have any questions regarding a trust agreement, you can call the IRS at 1-866-775-7474 or e-mail the Tax Shelter Hotline at IRS.tax.shelter.hotline@IRS.gov.

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