What are Estates and Trusts?
In the world of the IRS, a sum of money can take on its own identity and be treated like a person as far as taxation goes. This is so that money can be taxed even if nobody owns it. What this means is, there are certain ways of arranging money so that it’s not exactly owned by a person but rather exists on its own and is managed by someone called a fiduciary. Estates and trusts are sums of money that are managed and taxed but not owned by any one person in the traditional sense.
Why Are Trusts Created?
Certainly you’ve heard of a “trust fund baby”? These are rich kids who have a seemingly endless supply of money to finance their lifestyles. Well this almost always means they have a very wealthy older relative who has set up a trust for them. The rich relative is wise: he or she hasn’t given the money to the kid. For two reasons this isn’t wise:
- there is such a thing as a gift tax, so giving large amounts of money to someone means taxes will be paid
- giving a young person tons of money well then you’re messing with his work ethic
So a trust is created. It’s money that’s taken out of the rich relative’s accounts and put into a special account that he no longer really owns. It’s for the younger relative, buy he can’t have it either. The trust if managed by someone called the fiduciary and usually it’s set up to dole out the money bit by bit over the years, perhaps with full access when the kid turns a certain age like 20 or 30.
In the meantime, that trust takes on a life of its own in the eyes of the IRS. It gets a tax identification number (TIN) and also it will pay income taxes every year on the IRS form 1041. The TIN is quick and easy, applied for online. A lawyer or estate planner can choose to get and Employer Identification Number (EIN) online in minutes.
Why are Estates Created?
An estate is similar to a trust in that it’s a sum of money that’s managed by someone on behalf of someone else. In this case that someone else is deceased. A trust will become an estate after the creator passes away. Same goes for estates: they pay federal income tax on the IRS form 1041.
About IRS Form 1041
IRS Form 1041 is not very complicated. It’s set up just like a regular old 1040 form. There are three main sections on the first page and three Schedules on the second page and that’s it.
- Tax & Payments
- Schedule A
- Schedule B
- Schedule G
Income is easy. Deductions are the same ones actual people get, only there’s an extra one for trusts and estates: the income distribution deduction. If the trust or estate gave out any money to the beneficiary (or beneficiaries) then it’s a distribution. That amount can be deducted.
Schedule A can be skipped unless the trust or estate made a charitable contribution. Schedule B is for that Income Distribution Deduction I mentioned above. Schedule G is your calculations. Now that you’ve had a preview of IRS Form 1041 take a look at the actual form here on the IRS website.