The Internal Revenue Service treats an estate or trust just like a separate taxpayer and requires a separate income tax return on IRS Form 1041. Both a trust and estate can earn income just like any other taxpayer and the IRS wants to collect tax on that income. However, if the trust or estate incurs expenses to earn that income, then you can take deductions on the 1041.
Tax Expense Deduction
Aside from federal income tax, the trust or estate can deduct a range of state and local taxes it pays in the same way individuals can. You can choose between a deduction for the state income tax or the state sales taxes the trust or estate pays. Since the IRS gives you a choice, it’s beneficial to calculate both deductions and claim the larger of the two. If the trust or estate owns property for which it pays local property taxes, these payments can increase the deduction for taxes. Additionally, the taxes you pay to a foreign country can either be claimed as a deduction or a tax credit, which will reduce the trust or estate’s income tax bill on a dollar-for-dollar basis.
Fiduciary Fee Deduction
If you have a trustee or executor that manages the affairs of the trust or estate, then the fees the fiduciary earns is deductible from the income you report on 1041. However, if filing a 1041 for an estate, you cannot claim a deduction for the same fiduciary fees that you deduct on a federal estate tax return. You must choose which tax form to claim the deduction.
Whether you create a trust to provide regular donations to charity or you make the decision to donate some of the income or assets of a trust or estate you have an interest in, you can claim a deduction for them on the 1041 in the same way an individual taxpayer does. As long as the cash and property you donate is to a tax-exempt IRS qualified organization, you can report the deduction on a Schedule A and attach it to the Form 1041.
Net Operating Loss
In tax years the trust or estate has deductible expenses in excess of income, the result is referred to as a net operating loss. There is no tax benefit in the year the trust or estate incurs the loss; however, you can use it in other tax years to reduce taxable income. You must first try and use the entire net operating loss in the two most recent tax years. If there is insufficient taxable income to use the entire loss, you can carry the excess forward up to 20 years. For example, if a trust sells a stock portfolio at a loss this year, but has taxable income in the prior year, it can use that loss to amend the prior year return and receive a refund for income taxes paid.