Does A Revocable Trust File A Tax Return?

Where legal issues are concerned, the answers to most questions are  rarely simple. This blog post provides the full answer (the yes/no, the why, the exceptions and other related issues) to the question: Does a revocable trust file a tax return?

In transferring properties to beneficiaries, avoiding probate is one benefit that makes a revocable trust, also known as the grantor's trust, a better option than a simple will. Therefore, the property owner (the grantor) is saved the hassles of an expensive legal process of distributing the assets of a will (probate).

What Is A Revocable Trust?

A revocable trust a kind of living/land trust where the grantor can alter, amend, or cancel its provisions as they deem fit. The grantor has this power throughout his/her lifetime, after which it will be transferred to the beneficiary or beneficiaries, as stated in the trust. However, before this transfer, all income earned by the trust is owned by the grantor alone. The characteristic of the revocable trust to be solely alterable by the grantor is what makes it a grantor's trust.

What Is A Living Trust?

Another classification of trust instrumental to the question "Does a revocable trust file a tax return" is that of a living trust.

A living trust is a trust that is created while an individual (the grantor) is alive. Like with every other form of trust, a person is chosen to be responsible for managing the grantor's assets for the beneficiary's benefit. Living trusts are either revocable or irrevocable. Living revocable trusts are the point of focus in this post.

Why Use A Revocable Trust?

A revocable trust is an excellent alternative to a will. With a revocable trust, taxpayers can manage their assets and distribute them to whomever they choose as beneficiaries.

A revocable trust is great for estate planning because the grantor does not have to take his/her assets through the expensive and sometimes public probate process in the event of the grantor's death.

Revocable Trust Taxes

The effect of a revocable trust on tax liability is rather interesting. In a revocable trust, the grantor retains the right to receive the trust's income and principal (because of his power to manage his assets).

Consequently, the Internal Revenue Service views a revocable trust as a grantor's trust and, therefore, not a separate entity. The income from a revocable trust is not reported separately; instead, it must be reported on the grantor's personal tax return.

Does A Revocable Trust Need To File A Tax Return?

Having understood the characteristics of the revocable trust, people want to know the tax implications and the question that pops up in the mind of many, more often than not, is "Does a trust need to file a tax return?" A revocable trust or grantor's trust is a land trust, an agreement between two individuals: the property owner and the beneficiary. Before the grantor's death, taxes paid over the assets and their capital gains are made by the grantor. As seen on the Internal Revenue Service website, the grantor has to correctly input the taxes in the Form 1040 if he is the trustee:

The effect of this is that the trust will not exist for tax purposes as long as it remains a Grantor trust.

Taxes After Death

Upon the death of the owner, the trust changes entirely and becomes an irrevocable trust. The closest explanation that can be given for this is the testamentary trust, a type of irrevocable land trust. Once the grantor is dead, his rights over the trust properties are automatically transferred to the beneficiaries.

However, for proper distribution, a  trustee specified in the trust documents gets all the powers and rights the grantor used to possess. This trustee might be one of the beneficiaries. The revocable trust taxes will then be known as irrevocable trust taxes, and these are the kinds of taxes that require the filing of a tax return. The process to be carried out by the specified trustee is as follows.

• Get an irrevocable trust tax ID number—the federal tax ID, also known as the employer identification number (EIN). The specified trustee can also obtain the ID in the case the grantor becomes incapacitated.
• Ascertain whether or not more than $600 was made within the tax year.
• Visit the IRS website to download two forms: Form 1041 for the trustee and Schedule K-1 for the beneficiaries to show amounts distributed to them.
• Confirm the Schedule K-1 is the correct one as there are different versions.
• Report all earned income to IRS, directly related to the property or not.
• Report all profits and losses.
• Add all deductions of the owner.
•  Fill Schedule K-1 and Form 1041; give copies to beneficiaries.
•  Send it to the IRS.

Land Trusts, Living Trusts & Standard Trusts

A living trust is a trust that is helpful in avoiding probate. The name of the trust, living trust, comes from the fact that decisions about how a person's properties will be distributed are made while they are alive. Land trust means the same thing, except the properties involved are real estate or related assets. 

Both the land trust and living trust have revocable and irrevocable types and similar benefits, distinguishing land trust when you have a land trust vs. standard trust comparison.

Conclusion

• A revocable trust, either a revocable land trust or revocable living trust, does not require a tax return filing as long as the grantor is still alive or not incapacitated.
• Form 1040, the standard form required in reporting taxes for an individual, is all that is needed for a revocable trust, provided the grantor is alive.
• The revocable trust becomes entirely irrevocable after the demise of the grantor
• Form 1041 and Schedule K-1 are the two forms needed after the grantor's death.