Taxation of Nongrantor Funds

This is the last article in a three-part series on taxing trusts. The first part explored how someone can “intrinsically have trust”, in another meaning, what is commonly known among estate planning attorneys or trust and estate attorneys as “grantor credit.” It also considered the advantages of using grantor credit. here is a file Link For the first article in the series. The second article in the series examined the Taxpayer Identification Number (“TIN”) that trusts, including donor trusts, must use. here is a file Link To the second article in the series. This last article in the series discusses taxes on unwilling trust.

There is often confusion as to how a trust or sub-trust should report income and which tax identification number (TIN) to use. Treasury regulations make this very clear. Treasury Code No. 1.671-4 is the appropriate section.

A “non-sponsor” trust is a trust that no person substantively owns in accordance with the provisions of Section 671 et seq. A non-granting trust must obtain and use its own taxpayer identification number. The trustee must provide the trust’s Tax Identification Number (TIN) and address to banks and other organizations in which it holds assets.

The fund’s income is reported on the trust’s tax return, Form 1041. The trust will receive a distribution deduction for distributions that generate distributable net income (“DNI”). These distributions to the beneficiary who performs the DNI are then taxed on the beneficiary’s tax return. The trustee will provide a Form K-1 to the beneficiary informing the beneficiary of the amount of income the beneficiary must report on their tax return.

Let’s look at a quick example.

Mary established an irrevocable trust. The trust does not contain anything that would consider Mary or any other person to be the primary owner under Sections 671 et seq. In other words, a trust is a non-custodial trust or trust. The fund had an income of $50,000 a year. The fund distributed $20,000 to the fund’s beneficiary, Ben (Mary’s son). Those were cash distributions and a DNI implementation. Mary’s sister, Alice, is the guardian of the non-grant trust. Alice will file a Form 1041 with the trust and report an income of $50,000 and a distribution deduction of $20,000. It will also provide Ben with K-1 to distribute $20,000 to him. Ben will include $20,000 of income from the K-1 on his tax return for the year.

Both donor trusts and non-donor trusts have their place in estate planning. Remember, whether a trust is a grantor or non-grantor credit is not an indication of whether it is included in the grantor’s taxable estate. Property For tax purposes only Revenues tax purposes.

Stephen C. Hartnett, JD, LLM
Education Manager
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128

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