I'm an accountant with limited trust experience and often don't understand the trust document all that well. I saw one of my fellow accountants tried to ask a lawyer a question and they said to just read the trust document as if it should be obvious. I'm working on one right now that says early that it should be treated as a grantor trust for federal tax purposes when we for periods of time have one or more of the powers in IRC section 671-679. This makes it sound like it should just be on the personal but they did receive an SS-4 and it is called an irrevocable trust. I guess the key part is "periods of time"? So the grantor generally doesn't have those powers so we have to file a 1041?
Then I am trying to figure out if it is simple or complex or something else. It says all income must be distributed each year to the grantor who is also the income beneficiary. So at first I'm thinking simple. Then it says that during the grantors lifetime the trustee can distribute principal to the principal beneficiaries. So I would say it has to be considered complex based on that right?
I feel like I need to take a class so if anyone has a class on reading and understanding trust documents let me know. Thanks for any thoughts and help
How do you learn to interpret a trust document?
byu/Working_On_Tax_Stuff intax
Posted by Working_On_Tax_Stuff
4 Comments
I will be interested in what others say. Not a pro here, but my family does have trusts and so I’ve done reading, been around the block some, and we do file taxes around. This is from memory. Complex or simple, I think it depends on what happens during the tax year. Simple has certain requirements like all payments for the year have to be paid out withing 60 or so days from the end of the year. Certain other requirements. If not simple, then it is complex. So I’m guessing if the actually translations make it simple it is simple.
My personal example. We have one trust that is under a separate EIN. It can draw principle but we never do, and we always make certain we follow the simple trust distribution rules … so I think this is a simple trust. If for some reason during some year, we don’t or cannot follow those rules, I think we’d have to treat it as a complex trust. We file a 1041 for it, and issue a K1.
So I’ll be interested in what the pros say, but this is my understanding for what it is worth.
I hope those are typos because IRC 167-169 has nothing to do with grantor trusts. The grantor trust rules are generally found in 671-679 (with the powers causing a grantor to be the deemed owner in 673-677; 678 and 679 are beneficiaries treated as owners and persons treated as owners because of transfers to foreign trusts).
All income is ultimately reported on the grantor’s 1040 with a wholly grantor trust, but there are 3 ways the income from a grantor trust can be reported – you can choose to use an EIN for the trust or the grantor’s SSN/TIN, so filing an SS-4 doesn’t really tell you much of anything (nor does the fact that the trust is irrevocable).
The first (the traditional method) is by the trust using its own EIN, filing a nearly blank 1041, and issuing a grantor trust letter to the grantor to report the income. Any 1099s or K-1s would be issued to the trust under its EIN.
Under the first alternative, the trustee can issue a 1099 to the grantor to report income in lieu of filing a 1041, and again, any 1099s or K-1s would be issued to the trust under its EIN.
The second alternative is for the trustee to give the grantor’s name and SSN/TIN to any payors, such that 1099s or K-1s are issued in the grantor’s name directly.
This is an article written by a friend of mine that explains the options pretty well in depth.
https://www.mvalaw.com/media/publication/60_ABA_PP_v030n01__grantor_trust_income_tax_reporting_requirements.pdf
If the trust provides that all income must be distributed to the grantor and that principal can be distributed to the grantor, I’d look at IRC 677 – you almost certainly have a grantor trust with respect to income and may very well have a wholly grantor trust. There could be numerous other triggers too, but from what you said, 677 jumps off the page immediately.
And if a lawyer tells you just to read the trust, that’s a shitty lawyer (who may not understand the rules themselves). The grantor trust rules (and taxation of trusts in general) are super complex – there are a whole lot of lawyers and accountants who don’t understand them. Do CPE/attend conferences specifically geared towards taxation of trusts. I don’t think that how to read or interpret a trust is your issue (you were able to discern that it requires all income to be paid to the grantor and allows for discretionary principal distributions) – it’s understanding the rules of subchapter J and applying what you have read to those rules.
These are the slides from a Heckerling presentation a few years ago. They may have some things that are outdated, but they provide a great overview of the rules for the taxation of non-grantor trusts.
https://media.law.miami.edu/heckerling/2021/Supplemental%20Materials/Doyle%20-%20Fundamentals%20Program%20Demystifying%20Distributable%20Net%20Income.pdf
You definitely need to do some continuing education. I’ll let one of the accountants here point you in the right direction for that. To get started, you might get a copy of a supplement such as Federal Income Taxation of Estates, Trusts, and Beneficiaries in a Nutshell by Grayson McCouch (or a similar supplement). These are specifically designed for law students – in other words, people who are starting at zero and need to be taught the fundamentals.
To try to put it simply:
A trust can be characterized as either a grantor trust or a non-grantor trust.
If the trust is a grantor trust, it is not treated as having an existence separate from the grantor. In other words, the grantor reports all of the trust’s tax items on the grantor’s own personal income tax return as if the trust did not exist.
Administratively, there are two primary ways to handle this. The first is that the trust can simply use the grantor’s SSN. The second is that the trust can obtain its own EIN, file an informational income tax return indicating the trust is a grantor trust, and issue 1099s to the grantor. There is a third I have never actually seen anybody use. For some reason, some people like the optics of keeping the trust separate from the grantor despite the added reporting complexity. Ordinarily, you just use the grantor’s SSN.
A trust is a grantor trust as to the settlor (the person who created the trust) if the settlor retains any of the powers over the trust or interests in the trust described in Code §§ 673 through 677 and 679. A trust is a grantor trust as to the beneficiary if the beneficiary is granted an interest in the trust described in Code § 678.
If the trust is a non-grantor trust, then it will be sub-classified as simple or complex. A simple trust requires all income to be distributed at least annually. A complex trust is any non-grantor trust that does not require all income to be distributed at least annually.
The basic idea with a non-grantor trust is that either the trust or the beneficiaries (but not both) will pay tax on the trust’s income. The trust reports all income. It is then permitted deduction for any income distributed to a beneficiary. The beneficiary, in turn, includes the income received from the trust on their personal income tax return.
Because trusts are subject to compressed income tax brackets, it is generally preferable to avoid having income “trapped” in the trust – i.e., not distributed to a beneficiary at least annually.
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The gist of it is that you need to learn and understand Code §§ 673 through 679 to be able to read a trust agreement and determine whether the trust is a grantor trust or non-grantor trust.
If the trust document states that it “should be treated as a grantor trust for federal tax purposes …”, why specifically do you think it should be treated differently?