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TOPIC: Form 1041 schedule B

Form 1041 schedule B 4 years 1 month ago #1

  • Mike
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I have been reading everything I can about how to file form 1041 for the final year of the trust my mother-in-law set up to distribute her assets after her death to her 5 children. Before her death, she was receiving and reporting all the income of the trust on her 1040. She died 1/18/2009. I filed her 2008 1040 by the due date and have her 2009 1040 prepared. The small amount of interest and dividends that the trust account earned in 2009 were all received after her death. Since the trust account was opened with her social security number, We received the 1099's showing the year's income of interest and dividends under her social. I followed the instructions on the 1041 and subtracted the interest and dividends earned after death from her schedule B and entered these totals on the 1041. After her death we sold the stock and bond funds in the trust account and distributed an equal share to the children.

My question has to do with how to complete the 1041. There was a large capital loss from the sale of the funds in the trust account. I filled out the schedule D (1041)and the capital loss carryover worksheet. The $3,000 loss entered on line 16 and then line 4 of the 1041 was greater than the interest and dividend income so the total income on line 9 ended up to be a negative number. This carried over to line 17 and 22 also as a negative number. It appears to me that line 23-29 should all be 0, as well as all of schedule A.
On schedule B it also appears to me that since there was no income on line 9, there can not be an income distribution or deduction. If I do have to fill in schedule B what would I put on line 8. Since line 6 adds back the $3,000 loss taken on line 4, line 7 is the same total of 1 and 2a which is $1,040 in this case. The trust docs state that after death the trust should pay debts and distribute the rest to the children. I am just not clear on what they are looking for on schedule B lines 8-15.

Anyway, I filled out the K-1's, one for each child and entered on part III 11. each child's share of the long term loss carryover. I left blank 1. and 2a. because it seemed to me that the interest and dividend income the trust account received was wiped out by the $3,000 portion of the allowed losses on line 4 of 1041.

I have been searching for day's to find some information on these questions. When I found this site through Google, and read some of the articles written I got really excited. The depth of the answers is awesome. I would really appreciate some help.

Thank you all

Mike
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Re:Form 1041 schedule B 4 years 1 month ago #2

  • Michael P. Pancheri
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I'll respond to your question about completing Schedule B, but I have a preliminary question. You said that,
"There was a large capital loss from the sale of the funds in the trust account."
My question is how did you determine that there was a large capital loss? Since there is a step-up in basis upon your mother-in-law's death, the loss must have occurred from 01/18/2009 (her date of death) until you sold it. Is that how you determined the loss? We need to establish that first, otherwise everything else we say may be wrong.
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Re:Form 1041 schedule B 4 years 1 month ago #3

  • Michael P. Pancheri
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Yes, the reason I asked that question is because it seemed to me that some of the losses you incurred were the result of paper losses prior to your mother-in-law's death. For example, let's assume your mother-in-law purchased 100 shares of ABC company in 2005 for $20,000 and those 100 shares were worth $5,000 at the time of her death. Then, you sold the 100 shares for $4,000 after her death in 2009. The tax laws prescribe that the trust's tax basis for those 100 shares at the time of your mother-i-law's death is $5,000, not the $20,000 that she paid for them. Section 1022 of the I.R.C. says that, upon death, the tax basis is the lesser of the purchase price or the fair market value at time of death; i.e., $5,000 in our example above. So, when the successor trustee sells those 100 shares after her death for $4,000, the loss reported on the trust's tax return (Form 1041) is $1,000 [$5,000 - $4,000 = $1,000], not $16,000.

So, when you said you incurred a large loss from the sale of the funds, it just raised a red flag as to when those losses were actually incurred.

But, let's move on to your actual question, which is how to complete the 1041 in your case.

First, a quick overview of how trusts are taxed by the federal government. Since trusts merely hold property for the benefit of someone else, the tax laws take the position that the beneficiaries should pay the taxes on trust income, not the trust, because trusts are merely conduits of property from the grantor to the beneficiaries. Problem is, many trusts do not distribute all the income that they earn during a tax year - and that presents a couple of problems. First, from the beneficiaries' point of view, why should they pay taxes on income they might not have received? Second, from the federal government's point of view, why should trust income be allowed to escape taxation until the trustee decides to distribute it to the beneficiaries?

The result is a sort of hybrid system that goes like this: First, income earned by a trust is taxed to either the beneficiaries or the trust, but not both. If distributions are made from a trust, those distributions are deemed to consist of income first and principal second. If any income earned during a given year is not deemed to be distributed to the beneficiaries, then the trust will pay taxes on that retained income.

To encourage trust income to be distributed to beneficiaries currently (i.e., within the same tax year as it is earned), the tax laws impose much higher tax rates on income taxed to a trust than the rates on which the beneficiaries are taxed.

Since it is not possible to say with any certainty that any distribution to beneficiaries is income or principal or both, the tax laws presume that distributions are income first and principal second. So, if a trust has $100 of dividends and $50 of interest during year 1 and makes a distribution of $500 to beneficiaries during that year, then the distribution will be deemed to consist of $100 of dividends, $50 of interest and $350 of principal. And, the beneficiaries will then report those dividends and interest, pro rata, on their personal income tax returns for the year in which the distributions are received. The trust gets a corresponding deduction for the income distributed so that the income is not then taxed to the trust. That's the theory.

The actual mechanism for calculating the amount of income that is deemed to be distributed to beneficiaries each year is set forth in Schedule B of Form 1041. Schedule B actually consists of two parts. The first (lines 1 - 8) determines how much distributable income a trust has during the tax year, and the second (lines 9 - 15) determines how much of the distributable income can be deducted by the trust in determining it's own tax liability for the tax year.

In your case, you correctly showed that the trust had no adjusted total income (line 17) for the year because the $3,000 capital loss offset any other income (i.e., dividends and interest), plus any deductible expenses incurred in administering the trust (lines 10 - 15(b)). However, at that point you have to go to Schedule B to determine the amount of income deemed distributed to the beneficiaries and the corresponding deduction available to the trust as a result of distributing income to the beneficiaries.

In completing Schedule B, things get a little tricky with a net capital loss. First, let's look at the big picture. Again, let's assume the facts stated above; i.e., the trust has $100 of dividends, $50 of interst, and distributes $500 to the beneficiaries. Assume, also, that the trust also has a $10,000 net long-term capital loss for the year, of which $3,000 is deducted on line 4 of the 1041 and the remainder is carried forward. Note, too, that capital losses can only be distributed to the beneficiaries in the final year of the trust. So, the $7,000 long-term capital loss carryover belongs solely to the trust at the end of this taxable year.

So, the big picture here is that the capital loss can be used by the trust to offset any income taxable to it. However, it cannot be used to offset any income "deemed" to be distributed to the beneficiaries (except in the final year of the trust). In our above example, we know that $500 was distributed to the beneficiaries. Therefore, it is presumed that the $100 of dividends and the $50 of interest were deemed distributed first and the remainder of the distribution was principal. Since the $3,000 capital loss is not available to the beneficiaries, it cannot be used to offset the dividends and interest earned by the trust.

That's the theory. How does Schedule B get us to that conclusion? First, line 1 asks for the adjusted total income for the trust. This is the amount found on line 17 of the 1041. You might just assume that $0 should be entered on lines 4 and 17 of 1041 because the capital loss wiped out the income from the dividends and interest. However, the instructions for line 1 say that, if line 4 and line 17 are both net losses, then enter the lessor of the two amounts; i.e., in our example we would enter -$2,850 [$100 + $50 - $3,000]. So, figure the actual loss on lines 4 & 17 rather than just entering $0 on those lines.

On line 6 of Schedule B we would then enter the $3,000 capital loss as a positive number. When you subtract line 1 (-$2,850) from line 6 ($3,000) you end up with $150, which is the correct amount of trust income for the year.

Line 8 asks for the accounting income for the year. Accounting income may be different from taxable income. Most states, for example, do not include capital gains in accounting income. So, in our example above, the trust's accounting income would be $150; i.e., the $100 dividend and the $50 interest.

The remainder of Schedule B then goes on to determine how much of the trust's distributable net income (DNI) was actually distributed during the year, and that amount is deducted by the trust in determining its own tax liability for the year.

The amount of the DNI that is actually distributed to the beneficiaries is reported, pro rata, on Schedule K-1's for each beneficiary. Unless it's the final year of a trust or estate, a capital loss carryover cannot be distributed to the beneficiaries and should not be reported on any k-1s prepared for them.

While it gets a little confusing as to how trust income is calculated on Form 1041, it helps to understand the theory behind it. Please let me know if this doesn't answer your question or if you have further questions.
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Re:Form 1041 schedule B 4 years 1 month ago #4

  • Mike
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Michael

Just found your question.

I used the instructions for Schedule D (1041) to help me to calculate the Capital loss.

Page 4 of the instructions for Schedule D (1041) column (e)- Cost or other basis, Basis of trust property, states: "Generally, the basis of property acquired by gift is the same as the basis in the hands of the donor. If the FMV of the property at the time it was transferred to the trust is less than the transferor's basis, then the FMV is used for determining any loss on disposition."

The stock and bond funds were purchased through a Fidelity Investments account in the name of the trust from funds already funded to the trust. I assumed that the basis of these funds would be the cost, when purchased, which was FMV at the time, the same basis of the transferor. I assumed that the Sales price would be the FMV of the funds when sold by the trust, which was considerable less that the FMV at the time of purchase and also less than the FMV at the time of death. We have these figures available.

However, on the same page under the subheading: Basis of decedent's estate property. It states the basis of property acquired by a decedent's estate is the FMV at date of death, or alternate valuation date if the executor elected to use an alternate valuation under 2032. This didn't seem to apply to us since we are not electing the treatment in section 645 to treat the trust as part of the estate. Since the property was in the name of the trust already, I assumed that there would not be a related estate. I thought that the trust could just sell the property and distribute the proceeds to beneficiary's.

Also there was the decedent's residence that was also deeded to the trust. The cost basis when purchased in 2004 was considerably less than the value at date of death and date sold( which were about the same). This property was also reported in Part II of Schedule D (1041) and generated a Long-Term Capital Loss also.

It appeared to me that a trust is permitted to count this loss but an estate is not. This appeared to me to be another benefit of having a trust and reporting under the trust and not electing to be treated and taxed as part of a related estate.

I have to admit though, that I am no expert in this field. This is the first time that I have had to file a 1041 and related doc's. So I would greatly appreciate your professional opinion on these matters. Also, I am still unsure on how to proceed with the schedule B (1041)

Thank you very much for your help.

Mike
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Re:Form 1041 schedule B 4 years 1 month ago #5

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Michael

Just read the rest of your post which I didn't see the last time.
Great explanation. I think I understand better what Schedule B is supposed to do now.
I'll need some time to try to figure out how to fill out line 8 and the rest of the schedule.

One more piece of info though. About a month ago I spoke with an irs rep about this, in my efforts to figure it out, and he said that he thought that I could report the 1041 as an initial return and a final return at the same time. The status of the trust is that all the bills have been paid and the distributions made, before the end of 2009. Can we file this 1041 as the final return and so include the capital loss carryover in Part III line 11, on the K-1 to the beneficiary's?

Would this change the schedule B info regarding income distributed to beneficiary's---They didn't receive any income, did they? It looks to me that they only received a reduction in the value of their part of the corpus of the trust, in their distribution. The trust didn't have to pay any taxes on income because their wasn't any, is that right?

Thanks again for your expertise.

I need to get back to work now, but I would much rather stick around to get your thoughts on the matter. Oh well. :(

I'll check back as soon as I can.

Mike
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Re:Form 1041 schedule B 4 years 1 month ago #6

  • Michael P. Pancheri
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You definitely can file Form 1041 as an initial return and a final return in the same year. In that case, you can pass the capital loss carryover to the beneficiaries (as determined on Schedule D, Form 1041). Report the carryover on Box 11 of Form 1041, using Code C. Be sure to check "Final K-1" on the top of each K-1.

If filing as the final return, you still complete Schedule B as discussed above because the $3,000 loss is still included on line 4 of the Form 1040. You need to do that to correctly determine the DNI for the year. The beneficiaries will report their pro-rata share of the DNI and the capital loss, all of which is reported to them on their respective Form K-1s from the trust.

Nice job, Mike! How bout sticking around and helping others with similar questions. You could help a lot of people now that you've taken the time to navigate though all this trust tax stuff. :)
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