One of the benefits of the living or revocable trust is that it allows an individual to remove property from his or her probate estate by transferring the property to a trust. Because the trust, and not the decedent, owns the property at death, the property passes under the terms of the trust and outside probate. One question I frequently get is what are the complications associated with transferring the property to the trust during life and particularly does the trust have to file a separate tax return?
I am happy to report that typically speaking, the living trust does not file a separate return. Under the Internal Revenue Code, a revocable trust qualifies as a “Grantor trust.” Under the Grantor trust rules, the trust is “disregarded” and all the items of income or expense are reported on the Grantor’s Form 1040, as if the trust did not exist for tax purposes, at least for so long as the trust retains its “Grantor trust” status.
In order to report on Form 1040, the Grantor and/or Trustee must comply with a couple of fairly simple requirements. The Grantor must provide the Trustee (who is usually the same person) with a Form W-9 (the form that individual taxpayers use to provide third parties with the taxpayer’s social security number). The Trustee then provides the Grantor’s social security number (as reflected on the form W-9) to all parties making payments to the trust. While those parties may make the payments to the trust, they issue a Form 1099 to the Grantor that reflects the payment made by the payer to the trust. The Grantor reports the payments made to the trust and reflected on the form 1099 on his or her from 1040 individual income tax return. That way the income items are paid to the Trustee but are reported by both the payer and the Grantor to the IRS under the Grantor’s social security number.
These rules apply even if the Grantor is not serving as Trustee of the trust. If the Grantor is not the Trustee, the Trustee must comply with one additional requirement. The Trustee must provide the Grantor with a statement that: (1) shows all items of income, deduction, and credit of the trust for the taxable year; (2) Identifies the payor of each item of income; (3) Provides the Grantor or other person treated as the owner of the trust with the information necessary to take the items into account in computing the Grantor’s or other person’s taxable income; and (4) Informs the Grantor or other person treated as the owner of the trust that the items of income, deduction and credit and other information shown on the statement must be included in computing the taxable income and credits of the Grantor or other person on the income tax return of the Grantor or other person. Provided that statement is provided, the trust need not file a separate tax return, thus reducing the cost of administering the trust during the Grantor’s lifetime.