How to Prepare Form 1041 After the Tax Cuts and Jobs Act of 2017 (MLT918B)

  Pre Recorded Webinar
  240 minutes

Catch up on the Recent Changes and Get Line-by-Line Instruction on Preparing Form 1041

To report income and expenses, trusts and decedent’s estates must file an annual income tax return: Form 1041. But The Tax Cuts and Jobs Act of 2017 made many significant changes that impacted pass-through entities and their beneficiaries. If you’re preparing a U.S. income tax return for an estate or a trust, you must know what these changes are, and how the new law will specifically affect the preparation of your client’s (or your) Form 1041.

Don’t take any chances with your client’s (or your) tax return. Learn exactly how to prepare a Form 1041 – with line-by-line instruction on how to do it right. Join top-rated industry veteran Arthur Werner to find out what the compliance changes are, and how the new tax law will impact the preparation of Form 1041. Get an overview of and guide to preparing the U.S. Income Tax Return for Estates and Trusts (Form 1041) in light of the changes made to the Internal Revenue Code by the Tax Cuts and Jobs Act of 2017. Find out the specific issues regarding a trust, and get up to speed with Subchapter J of the Internal Revenue Code. Learn how to comply with Affordable Care Act issues, and get the skinny on distributable net income (DNI), income in respect of a decedent (IRD), and line-by-line instruction.

After attending this in-depth webinar, you will clearly understand how to handle Form 1041, and know to integrate the tax law changes into your fiduciary compliance and planning practice. Plus, you’ll be able to deliver better results for your clients.

Note: If you provide financial planning services to your clients, don’t miss this session. Werner has been rated as having the highest speaker knowledge in his home state of Pennsylvania, and has received several awards as well.

Session Highlights

After attending this session, you will:

NASBA & IRS Category of Study: Taxes

Level: Basic

Who Should Attend

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I would like now to introduce your speaker for today Arthur Werner. Arthur Joseph Werner, JD, MS (Taxation), is the president and is a shareholder in the lecture firm of Werner-Rocca Seminars Ltd. Mr. Werner’s lecture topic specialties extensively include business tax, financial and estate planning for high net worth individuals. Mr. Werner received his BS in accounting and his MS in taxation from Widener University. He holds a JD in Law from the Delaware Law School.

Mr. Werner’s lecture extensively in the areas of Estate Planning, Financial Planning, and Estate and Gift Taxation to Certified Public Accountants, Enrolled Agents, Attorneys, Insurance Agents, and Financial Planners, and has presented well in excess of 2500 eighthour seminars over the past 25 years as well as numerous webinars and video presentations.

Mr. Werner has been rated as having the highest speaker knowledge in his home state of Pennsylvania by the Pennsylvania Institute of Certified Public Accountants, was also awarded the AICPA Outstanding Discussion Leader Award in the State of Nevada, the Florida Institute of CPAs Outstanding Discussion Leader Award, and the South Carolina Association of CPAs Outstanding Discussion Leader Award.

Arthur, welcome to the program, we are now ready to begin.

Arthur Werner: And thank you Cyrus. Welcome everybody. I am happy to be here. Great day for a lecture. I hope that you’re going to be well informed and I hope that you’ll find this to be a good topic for your practice. Again my name is Arthur Werner and as Cyrus told you, I’m a principal of a lecture company Werner-Rocca Seminars. We’re based out of Philadelphia, Pennsylvania. We do a lot of lectures for Eli Financials. In fact, I’m happy to say that Werner-Rocca Seminars and Eli Financial have a very close relationship and in fact we do a lot of things together outside of the webinar business. We are expanding certain destination lectures that we are cosponsoring and we have some other projects that will be coming up and we’ll talk about some of those later today. But that’s not why you’re here, you’re here for the 1041. And I will tell you that I have been giving 1041 lectures now for a long time especially in the webinar format and I’m happy to be able to do it for Eli today.

The fact is, a number of people take a 1041 lecture and what I sometimes refer to as a hands-on lecture because we’ll be talking about the actual form itself at the later part of the day we’re going to go through the form line by line but there’s a reason why you’re here and probably it’s because you don’t have the same comfort level that you would have with a 1040. There’s a good reason why you don’t have that comfort level.

One reason or a good reason actually, one reason might be that you didn’t have the same experience that you have with 1040s. Think about it, when you are preparing your first
1040s, you probably work for a firm. There were people above you, you would prepare the 1040, that person above you would review it and would point out certain areas you might have made. And we learned that way. You never made the same mistake again. You would just learn what you did wrong and continue onward. And so this hands-on approach for 1040s probably made you a very good 1040 practitioner.

A lot of people tell me that they never had the same experience with 1041s and I understand that because a lot of times there weren't mentors on the firms you are at who actually could help you with a 1041. So sometimes when you were doing at 1041 you are stuck with it so where would you turn? If it was a compliance issue, not a law issue but a compliance issue, you would probably go to the instructions and a lot of you realize the 1041 instructions are difficult at that. In my opinion not one of the better instruction is published by the Internal Revenue Service.

And the reason that they are not as easy to utilize it's not the IRS’s fault believe it or not, it is the form of the entity theory. The entity theory says, hey we're preparing a 1041 for an estate or a trust, for example, these are not federal entities, there is nothing in the U.S. Constitution that allows the federal government to regulate estates and trusts. And so when the 10th Amendment, when the Constitution is silent, the 10th Amendment kicks in, the 10th Amendment says, any power not specifically granted the federal government belongs to the states and the people. This is a state’s rights issue and so every state can have different rules regarding their entities and these rules could affect the specific 1041.

I might have an estate or let's say a $1 million in Pennsylvania and a similar size estate, let's say in Nebraska, just pick a state for you or west of Pennsylvania. And it might be the same make up of assets but the 1041 might be different based upon state law issues. And so these are things that's difficult for the instructions to deal with. There is the distribution deduction which is a deduction that is -- has a created limit and the limit is that the deduction is the lesser of the actual distribution itself, the taxable income or the accounting income of the entity. And how do you explain that necessarily in a document? You have people or in instructions, you have people who have difficulty with the tax law, because maybe you didn't necessarily study subchapter J of the Internal Revenue Code. I know all the reasons you're here.

There are a lot more reasons than that and I don't want to spend too much time on an introduction because we have plenty of material today. But let me assure you this, I've given 1041 lectures for a long time. I know what your issues are and we're going to make sure that you feel comfortable. My job today is to make sure you understand the entities. My job today is to point out certain areas of subchapter J which are vastly different than the individual income taxes, and we'll make sure you understand that. And then finally my job today is to take you through a 1041 and make sure you understand that. Now I notice that the title has the Tax Cuts & Jobs Act of 2017 in it and the reason for that is that there were some changes in the tax law that will affect future 1041. I will point those out to you. I'll show you where those issues are and we'll make sure that you are comfortable with the new Tax Act and how it's going to affect the 1041 that you're preparing.

I do ask that you do something. You're not going to need it now, you'll need it after our break and maybe if you haven't done so already during the break you might want to get this, but I would like you to have in front of you a copy, a blank copy of a 1041. Now you don't need it now, but when we do the line by line it would be helpful to have it. The best place to get it if you don't have one handy is go to Go to forms and publications and just download a 1041 if you have extra screen on your computer and don’t want to print it, just put it on the extra screen. And if you don't have that luxury, print one out.

You're going to find unfortunately that the best, the most recent year you're going to be able to find will be 2017. The IRS has not yet come out with their 2018 form. Unlike the 1040, I don't expect many changes. There will be some but nothing significant. And so using the 2017 form, I'll be able to give you a very concise lecture as to how to prepare to be 1041 itself. There'll be some minor changes when the 2018 form comes out, and my feeling is that the IRS probably won't have that form ready until mid-December. And so since we're giving this course in September, it's just good to have a knowledge of this, but when the new form comes out if you do have questions, you'll be able to contact me and let's get to the question piece of this.

One of the reasons I really enjoy lecturing for Eli Financials is that I can do a webinar but still speak to you, and so here's how we will handle this and I know Cyrus told you this in the beginning but let me just reiterate. We're going to go 90 minutes the start, you'll see you'll hear me speak for 90 minutes and that'll take us to roughly a half past the hour if you're an Eastern Time, I believe 1:30, if it's -- obviously you adjust that time if you're in any other time zone.

At that point we will then open this up to questions, and the questions will be audio only which means that you'll actually speak to me directly. The system only allows us to do that so you'll be announced and we'll talk and we'll do that for roughly 10 minutes. I know that's not enough time for a lot of questions but don't worry because we're going to take a 15-minute break, we're going to then go another 90 minutes and then we're going to open up for questions again and I have no limit as to the time for those questions. We have a significant number of people attending this lecture today and I just want you to understand that I'll get to all of you.

Now more likely you're going to have questions when this is over. And my final PowerPoint slide does have my contact information, my telephone number, my email address. I get a lot of 1041 questions during what you call busy season and it's funny because see your busy season is not like this season because no one takes lectures or very few lectures. There are some but not a significant number of lectures February, March or April. And during these this time period, we at Werner-Rocco are preparing for next year's lectures. We're actually writing materials and so on. I'm in the office and I'd be happy to take your calls. So I get lots of 1041 calls and I’ll help you through if there's any questions you have.

So you're going to have lots of opportunities to ask me, talk to me. You can obviously do it during the lecture, you can do it when the lecture is over. Part of what you paid for, you paid good money for this program and part of what you paid for is access to me. And I'm happy to assist you in any way I can. I want you to make this part of your practice and I really want you to excel at this because this is good billable work. This is premium billable time. When you're preparing a 1041 don't give that work away. This is, you have every right to charge a nice fee for this and I hope that I'll be able to help you build a profitable practice in this area.

One final point before I go further, and for the seasoned Elifinancial veterans, you understand how this works. For those of you who might be new, we're going to have polling questions during this lecture. There'll be 10, 5 and 5 although it might not work out that way. You're going to clearly have 10 polling questions. They won't pop up, we will announce them. You'll have a minute to answer these. There's no right or wrong answer. It's either going to be multiple choice, yes or no or fill in a blank. It's just a method to prove that you're here. This is a must, the requirement for the CPAs. It is also an EA requirement that we poll you just to ensure that you are attending the class. But I will make sure that you know these polling questions are up. I want you to get credit for this class as well as learn a lot of good information.

So with that I am ready to start our lecture, How to Prepare the Form 1041 after the Tax Cuts & Jobs Act of 2017. So we'll start with an overview. Why are we doing 1041s? Well we're preparing 1040s because certain entities were created for planning purposes that are going to be separate and apart from your human clients and your business clients. What are these entities? These are trusts. For example you might have been involved in the estate plan or a financial plan of a client, hopefully you are doing that kind of work and if not get involved because it's good also good billing. But if you're establishing a comprehensive plan, there's a very good chance that you are as part of that plan is suggesting that trusts be established for either financial planning, estate planning or even ask for protection planning purposes.

These trusts are not document, they're not businesses. They will have income being earned during the time period and we have to account for that. The 1041 obviously does that. You might have the unfortunate situation of a client who passes away or a loved one of a client who passes away during the year and an estate is then open. And when the estate is open, there could be income that is being generated in this entity and we have to account for it on the 1041.

So today's class, we will be dealing with income taxation of estates and trusts under subchapter J of the code. We will deal with entities, estates and trusts. There are a few other entities that we do 1041s for, that's an advanced class that we talk about these. The charitable and so it might deal with the bankruptcies that we might handle with a certain specialized forms of trusts including what we call grantor trusts, the irrevocable grant or trust what you might know as a defective trust and so on.

We will be offering in 2019 a 2-hour webinar with Eli Financial on Advanced 1041 issues. If you would like this course and you think you want to go into those areas, I'm going to suggest you take that class but if you do have questions on areas that I just mentioned that are not going to be covered today, I'm happy to answer those also during the sessions as well as after this class is over.

Anyway we will be dealing with subchapter J as I said of the code. Subchapter J, good chance you never formally study this. If you did study, it means you probably were in a master's program because this would not have been an undergraduate class, income taxation of estates and trusts. And so you might say, well gee I don't know this so how am I going to learn this? Fortunately 80% of subchapter J is identical to individual income tax issues. And so what we will be doing today is that, we will be dealing with the differences and I will point them out in various sections of this class. We'll deal with some differences on income, a lot of differences on deductions. We'll show you some special issues that we have on subchapter J and I will even wait until we get to the form and I will deal with some questions there on subchapter J.

So we will become very comfortable with subchapter J. If you ever really want to really learn it, there’s like 13-week course, one hour a week, one night a week, three hours a night in any Master of Science in taxation program. But to prepare the 1041, I'll give you enough information that you will be comfortable with subchapter J at that level.

Now to start this, I want to make sure you understand the entities. And I also want you to trust me as to why I am putting this program together in this manner. I've had, again a lot of experience teaching these classes, and so one of the things I will do in the beginning is that we'll unteach you certain things that you might have thought you already knew. When we deal with 1041s in today's class, we will be dealing with estates and trusts. And so my question to you is what's an estate? And the answer is, well that's a bad word because for tax purposes, there's actually two definitions. We start with how your state defines what an estate is. So how does your state say it?

And by the way all states have this rule 49 in the 50 states following the English common law, Louisiana Falls, Napoleonic Code but it's still -- even if the differences between the French system and the British systems that we've adopted in the United States, the entity of estate is basically the same. And that is it's a legal entity that it established at the instance of death in order to protect and preserve all probate assets until the probate asses can be distributed to the individuals or entities who have a proper right to it. Now why do we need this estate entity? And the answer is because humans sometimes can't be trusted and if we're -- or maybe humans make mistakes.

And so for example what happens when a person dies? How does the wealth that individual transfer to another person or another entity or charity, and the answer is well if it was left alone to just our thoughts, we would have a free-for-all. Think of the old caveman times. Caveman dies and what happens to a stop? Well I’ve lived in a cave and so maybe he’s on the prime cave in his community of caves and if I died, maybe the first person who noticed I was dead would pull walk out of the cave and take over the cave. So first come first serve. Maybe there would be a battle over the stuff, maybe a bunch of cavemen we get together to have a – you can have them fight and the winner would take it. Maybe as the fight’s going on, some small cave person sneaks into the cave, steal some stuffs and leave. That’s cavemen time.

So just so you know, in the history of the world that's with a very recent time considering how old our planet is and have we changed radically since caveman at a time. The answer is, no not really. No significant differences between the way humans are now and the way humans were then. The difference we have is the law which clearly is not in the best interest of society. Therefore free for all, so how do we deal with this? The British dealt with it in one manner. And then that as I said, 49 of the 50 states have adopted the British system and this British system says that an individual has a privilege of distributing assets as that person desires and those desires are listed in the last will and testament. If a person doesn't have a will, then the state writes one for you, it's called the laws of intestate succession.

But before the beneficiaries have a right to assets, other people or entities have a right. For example, funeral expenses get paid out of it estate. I'm calling it actually the packing order of an estate administration. We first pay for funeral expenses, then we pay administration expenses that would be your fee, my fee. The executor personal representative commissioned someone. We then pay the debts of the decedent. Just because the person has wealth doesn't mean his obligations and the fee as well if he owes money, the creditors get paid. And then after that the taxing authorities get paid. The state might have a death tax, the federal government have a death tax for example and they’re based upon the gross value of the estate less all the debts and expenses. And so the net is taxed and that would be paid. And then finally this is a pecking order would be the beneficiaries, and they have a right.

Now this takes time and the time -- and because it takes time, we don't have an instant resolution of an estate. It could take two years, it might take more than two years to resolve an estate. And during that period of time there might be assets in the estate and these assets are being generating income and the 1041 will be filed to reflect the income being earned in that estate.

Now for federal purposes this is not the same definition and you said what do you mean? Are you talking about 1041? No, no, the 1041 is reflected of the state position of the estate. The federal position says, when it comes to our federal death tax, we're not going to limit it to the probate assets. See what's a probate asset? I use the word there. Probate assets are assets that are in the decedent's own name at the time of his or her death, that's what's in this, the physical estate is the best version of an estate. For federal purposes that's only a part of the federal estate because the federal purposes is assets you own in your own name plus assets that are controlled by the decedent at his or her death valued at its highest and best potential use. Now I just recited for you Code Section 2031 which is the first of the estate code sections.

And so for federal purposes it's not just the probate estate, it’s also things such as your share of jointly held property. It's also the death benefit of your qualified plans and your IRAs. It could be such that passed via designation such as life insurance proceeds, it could be a number of other things. It could be we can have a bank accounts or brokerage accounts that have payable-on-death or transfer-on-death designations. This is a part of the federal estate.

So when we prepare a 1041, which definitions are we using? And by the way these Code Sections that I show you on this slide just go through all of the various code sections that the federal government says is part of a taxable estate. If I was giving a course on a 706, preparation of the federal estate tax return or 709, the preparation of a gift tax return, we would be using these code sections. But we're not we're preparing a 1041 today. So for purposes of the 1041, we're going to use the state definition. Only assets owned by the decedent in his or her own name or part of an estate and these assets would be subject to the preparation of a 1041 or the income being generated from these assets.

Who is responsible? And the answer is, in an estate the person is responsible could be called one of a few things. Some states will refer to this person as an executor. The executor is a Latin based term meaning that is gender-based. So an executor is technically a male, a female would be an executrix, multiple males co-executors, multiple females come executrixes. Some states that does get rid of Latin, we speak English in this country so some states change the term to personal representative. It's the same thing, executive personal representative, the same thing but personal representative is gender-neutral.

If you die without a will, the state will probably a point, they could register or wills office will probably appoint what we call an administrator. And so these are all the same person. This is the individual, it could be an entity like a bank that has the fiduciary responsibility to ensure that the administration, the estate is done properly. When you prepare a 1041, you're not working for the estate, you're actually working for the executor/personal representative. And the reason is that the executor/personal representative is personally responsible for this, for what goes on the estate. If there is a problem that executor could be held liable. And so our job is to protect that person's interest.

And so you might think that when you get an estate, your estate that you're working for you're actually working for the executor/personal representative of that estate. So now you understand what an estate is, what is probate. I used the term already. The legal definition is the act of proving that an instrument purporting to be a last will and testament was executed in accordance with the legal requirements and the determining instrument validating thereby that came right from Black's Law Dictionary, the Law of dictionary that we use when I was in law school. Essentially probate comes from the Latin word the Latin word is probare, it means to prove and probate is a proving process. We’re trying to prove a few things, one the decedent’s will is the proper one because there could be a few will floating out there, maybe there's a forgery. So we have to – the court will determine if its proper and who will determine the rights and responsibilities of the people who are named within that will.

A probate court which is not -- your state might not refer to it as that. Many states called a probate court but some states called a surrogates court. My home state of Pennsylvania calls in an orphan’s court. They're all the same when it comes to responsibilities. The probate court is a special court of law having specific jurisdiction of proceedings incident to the settlement of a decedent’s estate. And when we prepare the 1041, there's a very good possibility that if we're to say in any way that the 1041s will also be submitted to the court for review to determine the responsibilities of the estate to pay the taxes thereby.

And so anyway, now you understand what the state is in a really relatively quick manner so now I'm going to go to the second entity that we deal with. And by the way what I just taught you, you might say, well gee I didn't understand it that way. I know I reason and I need you to trust me as to why I go through this process here. I want to make sure that you do understand all aspects of this and it's important that you do know how an estate operates and quite shortly how a trust operates. But yeah, if you don't understand the operations then, the 1041 will not make a lot of sense. So I'm going to ask you this to trust me why I'm doing this because when we get to the 1041, you're going to say, ah now I know why he taught me this.

So let's go to the second entity that we'll be dealing with today that is the trust. And just so you know from the aspect of the 1041, you'll be doing a lot more trust returns than you would be doing estate returns. The reason being is that, an estate happens once. Obviously a person passes away and so it happens once and this hopefully for a limited period of time. We don't want these things going on forever. We're looking at somewhere between one two three years of in general. There could be some estates that lasts longer than that but usually they're closed out within a reasonable period of time. A trust on the other hand we can establish multiple trusts for various clients and these trusts can last for a long time. In certain cases they can last generations. So you'll be doing more trust 1041.

So what is a trust? Go back to my old definition of Black's Law Dictionary, it might take full definition out there and I found that the trust was defined as a right of property real a personal held by one party for the benefit of another. And you might say, that doesn't explain anything than you are. I just wanted to show you what we had to put up with in law school. Essentially what is a trust? A trust is a device of protection. It is holding an asset. And they're holding the asset because quite frankly, we want to control the use of that asset by a beneficiary.

Maybe we want to control because the beneficiary is limited in rights. I might want to establish a trust where I say, if I die my wife gets the income from the assets of my trust but upon her death I want my daughter to get the principal. So I'm trying to control the deals of disposition of the asset. Maybe I'm trying to protect the beneficiary because they're a mine or they're incompetent and we don't want third parties taking advantage of them. The trust can service that purpose. Maybe we don't want the beneficiaries to have access to income until a certain age. It might not be because necessarily they're immature but maybe we want to make sure that they work for a living. My biggest fear of when I was younger, my wife and I have a child we didn't want my child -- and we have a lot of life insurance just so you know.

So let's say, we between wife and I we have $2 million of life insurance. If we both die, didn't want my daughter getting $2 million outright because maybe she would say – yeah she might be responsible, she might say, gee I don't need to go to college now. I have $2 million. I’ll pocket in investments, I'll live off the investments. I don't think that that would have been a good idea. And so my trust might have held back the right to this wealth until she reaches a certain age. Maybe I said you don't get that assets until you're 30. We might have ways to pool the assets that we'll get to that shortly earlier than that but we want you to go to school, we want you to get a job, we want you to have responsibilities and then you can enjoy the fruit of these assets. And so the trusts are set up to do this. A trust implies what we call the bifurcation of an asset into legal and equitable title. Bifurcation means split into two.

So I want you to imagine this. I'm kind of a dramatic speaker when I'm live in front of you. So right now I just took my glasses off and I'm holding in my hand. I'm going to say what does bifurcation of an asset into legal title, equitable title mean? Well my glasses that I'm holding right now, I own them legally and I'm also the equitable owner of these glasses. The legal owner I can the following things. I can sell them, I can give them away, I can lend them, I can throw it to you, I can throw them away. This is what a legal owner can do. If they had value, I can take them to a bank or a pawnshop and use them as security for a loan as an example, that's what a legal owner can do.

What kind of beneficial owner do? Well imagine I just put my glasses back on. As the beneficial owner, I get to use the asset. Now generally when we own something, we own it in both ways. We are the legal title and the legal owner and the equitable owner. When we put an asset to a trust, we're actually only transferring the legal title of the asset to that trust. The equitable or sometimes known as the beneficial title to the asset belongs to the beneficiaries of the trust itself. And that's why a trust works by the way from a legal perspective. It's why it's great asset protection tool, why it’s a good financial and estate planning tool because of this bifurcation.

When it comes to the income in the trust, actually it's kind of interesting because if you think about it, the income stays in the trust the trust is going to be tax on it, but if the income is distributed to beneficiaries, the trust will get a deduction and the beneficiaries take it up as income and it’s actually kind of based upon the theory of bifurcation. Who is keeping the income and then who is responsible for paying the tax on that income? Now Cyrus, I just put up polling question number one. So while we put that first one up and just so you know ladies and gentlemen, when you see the polling question come up, you have a minute to answer it and they're not coming at even intervals. We do that intentionally because we just don't want you to come back every 10 minutes and answer a question. So don't worry that we went a half hour and got your first polling question. They will all come throughout this lecture.

Anyway it's a polling question you see up there is, do you need CPT credits this year? So yes or no? And I know I'm not going to go through this all the time, this length but I just want to show you what a polling question is for you, for people who are new to Eli Financial. Obviously there's no right or wrong answer to that but by answering it, you will get your credit for today. So it will be up there for a minute, you still have about 20 seconds left the answer. Please do so and as you're doing that, I'm going to move to our next slide.

Now all trusts have three players responsible key people or entities that are involved in the trust. And when you're preparing a 1041, the first thing you're going to do when you get a trust document is you're going to look, read the document and determine who these players are. And just so you know, the first two players are basically listed in the first line or two of the trust. And then the beneficiaries are later on or listed. So who are the three players?

The first player is called the trustor. Other names for this player is called the settler and grantor, they're all interchangeable names. So if you see any one of these names, it's the same thing. What is the trustor? The trustor is the individual who causes the trust to be created usually goes to an attorney, and the attorney upon instructors of the trustor will draft a trust document. The attorney -- the trustor rather is usually the person, not always but usually the person who will fund the trust with assets, take the assets out of his or her name and put it in the name of the entity. So that's the trustor, the person who causes the trust to be created.

The second player is called the trustee. Now the trustee can be human. It can be a nonhuman entity like a bank or trust company. The trustee is the fiduciary that has the responsibility of making sure the trust is being properly managed just like an executor of an estate. We work for the trustee. We don't work for the trust. When we are engaged to prepare a 1041 for a trust, we are engaged by the trustee and we -- and that's who we show our allegiance to, because what we're doing is we're protecting the trustee. The trustee could be personally liable if mistakes are made.

What are the functions of a trustee? And I'm going to tell you there are many functions. A lot of minor ones, there were five major ones. I want you to listen to the five major functions of a trustee and I want you to then think who am I referring to. So major function number one of a trustee is to manage the trust wealth. Second major function of a trustee is to make distributions in the trust in a -- from the trust in accordance with the trust document and/or the rules of the trust. The third major function of the trustee is to account to the beneficiaries as to what they're entitled to.

I suggest to be done at least on an annual basis. All beneficiaries have right to understand what's going on. The fourth major function of a trustee is to -- from time to time account to the courts as to what's going on. This is what a probate court says, hey there's been a dispute registered here and we need to understand what's going on. So they might be responsible of the trustee to account to the courts. And then finally the fifth major function of a trustee is to comply with the tax law by filing the proper tax returns for the trust to sell. These are the five major functions. A lot of minor ones like I said but these are the five major ones and what occupations that I just described.

And if you are thinking, he just described me. Yeah I did. Accounts enrolled agents, other tax professionals make tremendous -- make wonderful trustees. You are trained already to do this. Now for the accountants out there who are listening, I want you to be careful if you are doing auditing work for a client, you probably should not be the trustee of their trust because that would compromise your independence. If you're not doing auditing work or you're an EA and you're doing tax work or other tax professionals, I have no problem with you being the trustee of a trust. In fact I suggest that you consider adding this to your practice.

Now be aware that if you do add it to your practice, you need to contact your malpractice carrier. You're not necessarily covered by malpractice insurance for misacts of a trustee. So make sure you're covered and if you're not covered, get it added on to your malpractice policy because, you just want to cover yourself. But you may of course a little more in premiums so I think it's well worth it because it could be a nice little add-on to your business. And for the right practitioner and the right clients, it's a win-win scenario.

Third player of a trust is called the beneficiary. These are the humans or non-human entities. A good example of a nonhuman beneficiary would be a charity for example. These are the individuals or entities who receive distributions from the trust at some time. There are many types of beneficiaries. An example, we could have an income beneficiary. This is a person or an entity who received a stream of payments for a period of time. We could have what's called a remainder beneficiary. A remainder beneficiary is a individual who receive or entity who receives the principle of the trust at a later date. We could have a contingent remainder beneficiary. This is a beneficiary who receives the assets of the trust based upon an event that might have occurred.

So let me give you an example. I create a trust entity as follows, income to John for the rest of his life remainder to Jane, if alive if not to Sally. John is the income beneficiary, Jane is the remainder beneficiary, Sally is the contingent remainder beneficiary. Sally only gets it Jane dies before John. And in any case, if you add up all their interests of eventually, 100% of the distribution of the assets will occur because these beneficiaries will represent 100% of all the assets in the trust at some given time.

You want to look for these players, the first thing you do in a 1041 is identify these. You're going to need to know who these are. Next thing we do with for 1041 prep purposes is that we need to classify the trust. Unlike an estate, well an estate is an estate. Trust can be classified in various categories. And so I came up with a method of asking three questions and I'm going to suggest that you create a permanent file based upon these questions. The first time you read the trust document, you're going to answer these questions and you want to answer them in a way that you can then make it like the first page of that 1041 file so that when you do the 1041 the following year, you don't have to reread the document. You can just take a look at your notes and your notes will suffice.

And so one of the three questions, I'll show you what they are but they're simple but they do break things down appropriately. So what is question number one? And these are not polling questions so this is not a polling question. These are my questions here. Question number one how is the trust created? Now when we create a trust, the goal we created one of two ways. A trust can be either what we call inter vivos or it could be testamentary.

So inter vivos, another one of these Latin words. Have you ever wondered what the heck are we using all this Latin for? You might remember in your study is that, the Roman Empire actually for a while controlled what is now the island of Great Britain. And so they were there for maybe a couple hundred years I guess. And during that time period they left the law. And so even though they retreated from there, their underlying law was left there. And so therefore the underlying British Common Law is actually Roman Law. And so the that's why you're seeing all these Latin terms just so you know.

Anyway, what does inter vivos mean? I means, in Latin it means during life or while alive. What you might know is a living trust. Now a living trust is a separate legal document. Separate from what? Separate from a will. So if you’re taking –if you’re looking at a trust document and is not part of a will, it’s an inter-vivos trust. The other way we can create a trust is called testamentary.

Now testamentary means if the trust is actually written into the will, last will and testament of the decedent and what does that mean in English? It means that there is no trust that is working until your client dies and so since it’s in the will and will is not –has no legal bearing until the death of a client because the will can be changed, altered, amended at any time and so if you’re establishing a testamentary trust, it means that you don’t need it to work while you’re alive. You want it to be a working at death whereas in inter-vivos trust as soon as it is executed by the trustor and the trustee and it is funded that assets are placed into this trust. At that stage, we have a viable document and interesting question you’ll see when we go over the 1041, the question is actually at the top of the 1041 and what I called description part where – or the information portion of the 1041 and it is Box D on the upper right-hand corner and Box D says date entity created.

So what is the date that the entity has created? Just so you know that it wasn’t a state. It would be the date of death of the deceased. So what’s the day of death but if it’s a trust, the date the entity is created has to meet two conditions. One; has to be executed by the parties and two; it has to be funded. So inter-vivos trust means that the trustor or the trustee has signed the document and then the trustor has transferred asset to the trust. At that stage, we have a 1041 entity and that would be the date that it is created.

When it comes to a testamentary trust, the date that the entity is created is the – at first what creates execution and the answer is believe it or not, death of the client. The client has signed the will, the will is published for probate, there’s your execution. Funding is when the executor of the estate transfers his assets out of the estate into the trust. And that might not be for years. It could be a couple of years until that occur. If that’s the case, two years go by and then we fund it, now that’s the date of that entity is created. So there’s your differences and from our planning standpoint, just so you know the intervivos trust work while the trustor is alive where as a testamentary trust is meant to occur only at the death of the client.

So let’s get into our next poll, our next question –what I called the three questions. Again this is not a polling question. Question number two; can the trust be changed, altered, amended, or revoked? Simple question and there’s only two answers, yes or no. If we answer the question yes, we have what’s called a revocable trust and what’s special about that? A revocable trust is also –is a type of what we called grantor trust. A grantor trust is a trust that is a disregarded entity for 1041 purposes. All taxable income and all deductions in a grantor trust are reported on the trustor’s 1040.

So we don’t even –we have a reporting issue here. So all –if the trust is revocable at the most that we would do on 1041 might be to let the IRS know it’s revocable. We have complete the upper quarter of page one what I refer to as the information section, you attach a statement to the trust saying that this is a grantor trust and describe why it is. In this case it’s –because it’s revocable, you then say all taxable income and deductions under the ID number of this trust are reported on the taxpayers 104 –on the trustor’s 1040, his name is John Smith. His Social Security Number is 123456789 and by doing that, you’re letting the IRS know where to look for the income and the trust itself.

Now if the trust is—cannot be changed, altered, amended, or revoked, the trust is irrevocable and now you have some interesting 1041 issues with irrevocable trust. We’ll get to all this specific of this later in the lecture. Do know this. The revocable trust will become irrevocable when the trustor dies. It is the trustor who has the right to change, alter, amend, or revoke the trust and so if we have the death of the trustor that will create irrevocability and suddenly that revocable trust might turn into an irrevocable trust.

Let’s move to our next slide here. I have caveat before I get to my third of that three questions. The caveat is four questions I’m going to ask you and obviously you just got to think about as like giving the answers but I want you to – when you start thinking about these questions, I think you’re going to be pleasantly surprise, yeah I knew the answer of that and why do I put this here? I want to show you that we’ve been introducing to you some new vocabulary and I want you to start thinking about the use of this vocabulary. It’s going to be important and if you’re going to answer these questions, you’ve mastered the vocabulary.

So caveat question number one, can you have irrevocable inter-vivos trust and people are going to say well yeah, you can have that and you might go to caveat questions number two, can you have an irrevocable inter-vivos trust and you can say yeah an inter-vivos trust could be revocable or could be irrevocable. So if you’re saying yes, you can have those, good but see what I’m really getting at is you understood the terms.

Well let’s get to the third one so you really understand the terms can you have a revocable testamentary trust and I’m going to say probably most of you are thinking no and you’d be right and why? Because in order to have a testamentary trust, that means that the testator or the person who wrote the will has died and the only person who could change, alter, amend, or revoke that will is now dead. So by definition, if we have a testamentary trust, it must be irrevocable. So the caveat answer would have been yes, yes, no, yes and if you understand that because the fourth question was can you have an irrevocable testamentary trust which is yes, you now understand all the vocabulary I’ve been teaching you.

So let’s move to our next slide and this is the final of our three questions. Again this is not a polling question. This is one of my questions. So for federal income tax purposes, how is the trust classified? Three ways to classify trust. Actually a few more than that but for purpose of this question, only three are necessary answers and a lot of these would be in Box A of the upper part of 1041. So if you do have a 1041 in front of you now, Box A says check all that apply. Some of these would be –these would be fitting within that. So what are the three classifications I want you to know for today’s lecture. I want you to know what a grantor trust is, what a simple trust, and what a complex trust is.

So what’s a grantor trust? To reiterate a grantor trust again is a trust that is a disregarded entity. All income in a grantor trust is reported on the trustor’s individual income tax return, all deductions are reported on that 1040 of that individual. So disregarded entity and all revocable trust or grantor trust, some irrevocable trust or grantor trust, that’s outside this scope for today’s lecture by the way. That’s part of my advance lecture where I talk about the irrevocable grantor trust. This will be defined in the Code Section 671 through 679. The code will be called a grantor trust rule. They still exist. A lot of people thought they would be eliminated with the new tax act but they haven’t been so there’s still law.

And outside the scope for today’s class but if you want to learn more about those, you can ask me questions either today or you can ask them after the lecture is over. I’m happy to assist you. So the grantor trust again disregarded any so what if we have an irrevocable trust and it’s not one of the special irrevocable –an irrevocable grantor trust. It it’s irrevocable and is not a grantor trust, it’s either simple or complex. So what is simple trust?

A simple trust is a trust that the trustee is required to distribute all the income on an annual basis. There is no option. They must distribute all the income. What do we get for a simple trust? Well we get an exemption and by the way, you might know that for humans, exemptions were eliminated under the Tax Cuts and Jobs Act of 2017 but they were not eliminated for trust. So we still get exemptions but the exemption for trust is not based upon people and the trust. It is based on the type of entity. In fact the exemption for any 1041 entity is based upon type of entity. So we have an estate, the exemption of an estate is $600. If it’s a simple trust, our exemption is $300. If it’s a complex trust, our exemption is $100 by the way and I’ll explain what a complex trust is shortly.

You can say big deal Art, there’s not much difference between 600, 300, and 100 and I’d say you’re right. Why such a low number and the answer is these were the exemptions in
1976 under the 76 Act and there is no cost of living adjustment ever put to these and so the exemptions have stayed the same since 1976 and obviously significant inflation since then. So you have a scenario where the exemption is not that big a deal, probably one of the reasons why they didn’t bother eliminating them, no need to where they’re already essentially zero.

Now what is LC and with a simple trust? Well what we have is what we call a deemed distribution and what does that mean in English? If we have income in a simple trust, you must distribute all the income to the beneficiaries if the trustee didn’t do that. If the trustee didn’t distribute the income, it still deemed to have been half-done and therefore the trust get the distribution deduction, the beneficiary picks it up as income on the return. So I’ll give you an example. Let’s say I’m the trustee of a trust and I’m giving this lecture I have one these, oh my god moments, the trust that a 1231 year-end is now September and I said, you know, these beneficiary I never kind of check to them. No one said anything. I do not –so as I’m giving this lecture, I have my checkbook here and I’m writing the checks and we’re sending them out.

So what year would the beneficiary report that income and the answer would be they reported on the 2017 return, not the 2018 return. They got it in 2018 but they were supposed to get it last year deemed distribution and that becomes a legal problem.

Now what’s a complex trust? If you read the instructions, that is not a simple trust.
Horrible answer. So I’ll explain you a little better. It’s a non-grantor trusts that’s not simple and you can say that’s just as bad a definition. How about this? It’s a trust where the trustee is not required to distribute all the income on an annual basis. What do we get for that? We get two things. One, a $100 exemption which again is essentially zero but two, we get what’s called a 65-day rule which we also get for estates and this is –this came under the 1997 Tax Act. What is the 65-day rule?

The 65-day rule says that if we distribute income from the trust or the estate from the complex trustee of state, after year-end but within 65 days of the year-end, we can make an election on the 1041 to say pretend it happened on the last day of the year and we would get our distribution deduction, the beneficiary would pick it up as income in the prior year. So why would you want to do that? The answer is the trust tax rates are so compressed, we get to the highest bracket with relatively little income and one of the things we might want to do is past post the bet. We wait until the year end, goes by. Let’s say we wait through the month of January, we get over 1099’s and then in tax season, you accelerate the 1041 to the top of the list. You prepare the 1041 first and then you can prepare up to what we called the distribution deduction.

You can then go to the trustee of the trust or the executor of the estate if it’s the estate and explain that here’s what the tax will be. You can then ask what is the marginal tax bracket of the beneficiaries if it turns out of that the marginal rate is lower than the tax rate of the trust or the estate, the trustee or the executor might want to consider making a distribution and get distribution, we get the deduction at the entity level, beneficiary picks it up as income but they pay less tax than the trust would. So it gives us a planning opportunity and we get that with complex trusts.

So I have a fourth question here. What is income? I didn’t give its own slide and I can make some jokes and I can say it’s because it’s an insignificant question but you might say Arthur that’s the reason I’m here. I have some problem with that. In fact it looks like you use the bigger font, you used all caps and used the grammatically incorrect five question marks on that slide. So you might say hey you probably think it’s a bigger deal than you and you’re saying and the answer is it is. See what is income?

If I can physically see you, I might point to people and say hey talk about income is and a lot of people would say well interest as dividends, its net rental properties, that royalism patents, I’d say well I didn’t ask you for types of income. I’m asking for a general definition but since you gave me types of income let me ask you this. What about capital gains? And some of you would say yes and some of you would say no. It belongs to principal and then suddenly we get to debate.

Because we know the capital gains are taxable income so when we talk about the income distribution deduction, what we’re talking about is accounting income. We’re not talking about taxable income or distribution deduction is limited to the lower of taxable income accounting income or the actual distribution itself. And so when looking at income, we had to figure out hey what is the amount of income or maybe we want to define it differently.

See, how do you define what income is and the answer is for accounting purposes, you’re going to look to the income and principle act of your state because essentially what the income and principal act is saying is when establishing a trust for example, we need to protect the interests of all beneficiaries and the interests of the beneficiaries might be different. Let me give you an example. What if I created a trust that said income to my wife for the rest of her life, remainder to my daughter. Well how much is my wife get and you can say well she gets all the income. Unless I may say well, you know, I made my daughter the trustee of the trust. My daughter invests in the following stocks and I’m not going to say she even did it maliciously. She just did it. Microsoft, Oracle, Dell, Intel, Apple, Comcast, I take six stocks that are, look I know it’s not a diversified portfolio. It’s all tech or tech related but what’s special about these stocks is that they don’t generate a lot of dividends. They are meant to be growth-oriented stocks.

And so if in fact we said income is the dividends being generated, my wife gets a very little amount of income if the stocks grow in value, the principal increases and when my wife dies, my daughter gets a much fatter principle. Is this what I intended? The answer is no. I really wanted my wife to get an income stream. Now you might say well your
Pennsylvania might have a law that we have in our state that says a trustee has a responsibility to invest appropriately. We call it prudent investor rule meaning that if there’s an income beneficiary, you have to at least attempt to get some decent income for that person. That being said I could have put a cause in my will that said the trustee has the right to invest in any manner they deem appropriate without verification.

So it means they don’t have to account for what they’ve done and so how do we determine what income is and the answer is the income is defined for income beneficiaries in your income and principle act as interest dividends net range from properties, net range from patents, but capital gains are related for the principle. The corpus gets the –takes control of the capital gain and that does not – would not necessarily be income.

Well I can override this and really what we’re going to be doing there in a 1041 is we have to review the document and look for what we call the overrides. I can define income anyway I want. The Income and Principal Act is essentially a back-up law that says that the document that doesn’t describe it, here’s what it is. I might want to describe it differently and maybe I’m afraid that my daughter might make investment decisions that are not necessarily what I wanted. Not that she was trying to do something against her mother but maybe she just didn’t know better.

So if she invested in all these growth stocks, my wife would get insignificant income. I didn’t want that to happen. So what if I did this? I create a trust that says income to my wife for the rest of her life but for purpose of this trust, income shall be defined as and my definition might be $80,000 a year. We call that an annuity. Every year my wife gets $80,000. The trust generates more than $80,000, the balance stays with the principle. The trust generates less than $80,000. My wife gets the difference made out of Corpus. In that way I guaranteed my wife an annuity and my daughter is not saddled with a responsibility to try to invest appropriately. She can invest in what she think is a good investment and my wife still gets $80,000 a year.

I can set up what’s called a unitrust. A unitrust says income is defined as a fixed percentage of the principal. So I might say each year my daughter – each year, my daughter as the trustee will note what the principal balances of the trust on December 31 and she will get 7% of that for example to my wife. So every year my wife gets 7% of the principle. Unlike an annuity trust, a number that can change each year, if the principal goes up in value, my wife gets more money and if the principle goes down, my wife gets less money.

Now you understand what an annuity trust and a unitrust is and when we deal with the income distribution deduction, we look at the rule of what’s being distributed and if we’re looking at, for example what is a simple trust? If we define income as an annuity and we pay the annuity out, it’s a simple trust even though there might be additional income that was earned over and above the annuity amount that have stays in the trust then we might still have a tax at the trust level. I wanted to introduce this term income to you now because I think that was important and when preparing a 1041 that’s actually an extremely important question.

So now you understand the three questions. You understand the income. This is how we started 1041. We look at these questions that we deal with them accordingly. Now what is a grantor trust? I’ve already explained it. I have a slide on it. I’m running a little behind schedule so I’m going to skip the grantor trust slide because I’ve already talked about them. And now Cyrus I am at polling question number two. So if you can please put that up, it’ll be coming up shortly and like before they’re going to ask you for an answer, you will program the answer into the box. I’m still waiting for it to pop up but it hasn’t popped up on my screen yet. I don’t think it’s popped up on yours either.

Cyrus we do need that –I think is attempting to put up. There we go. It’s up now. So this time we’re going to put a word in. Just type the answer where it says type your answer here, no words, just the letter, anyways CAT DO5 make sure you get that answer in and get your credits for the day and as you’re doing that, let’s move on because I have about a half hour to our first question answer session. I have a few more things I need to cover before we get to that.

I have a slide here on what a simple trust is. I re-described it for you. Let’s just reiterate this one more time and if the trust instrument requires that all income must be distributed currently. The trust instrument does not provide in any amount or to be paid, permanent set aside or used for charitable purposes and the trust does not distribute – does not distribute amount allocated to the corpus of the trust. So I think I defined that for you in depth here but we’ve already gone over that, nothing significantly new on this....

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Arthur Joseph Werner, JD, MS (Taxation), received his B.S. in Accounting and his M.S. in Taxation from Widener University. He holds a J.D. in Law from the Delaware Law School. His lecture topic specialties extensively include the areas of Estate Planning, Financial Planning, and Estate and Gift Taxa... More info


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