Checklist For Preparing Form 1041 (Estate and Trust Income Tax Return)

Important Factors To Consider When You Prepare Form 1041

I have had a number of fellow tax professionals that have called me for assistance. I hope this webpage about completing Form 1041 will  answer some questions.

According to a leading Form 1041 expert, most 1041 forms are not prepared correctly, and the IRS usually doesn't care. Why?  Most of the incorrect tax returns error in the favor of the IRS.  The beneficiaries, not the IRS, are harmed.

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David M. Kaufmann, CPA

Voice: 720.493.4804

Email: contact2@kaufmann-cpa.com

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Fruita, CO 81521

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Similarities between Form 1040 and Form 1041

  • You want to include items of taxable income on Form 1041 and Form 1040. Make sure that the 1099 forms were sent to the taxpayer have corresponding numbers on Form 1040 and Form 1041. (If Form 1041 does not cover calendar year, you may not be able to do this.)
  • Many items that are deductible on Form 1040 can be deducted on Form 1041. There are notable exceptions to this.
  • BTW, a Trust and Estate Income Tax Return is often called a Fiduciary Income Tax Return.

preparing Form 1041

Differences in preparing Form 1040 and Form 1041:

(You might want to consider this as somewhat of a checklist for preparing Form 1041. These are some items that should be considered if you do not want the Internal Revenue Service to make out like a bandit.

  • If an asset, such as the security or real estate, has been sold by an estate make sure that the cost basis is not what the decedent paid but is the date of death value. Later I will discuss some items that can increase the cost basis above the date of death value. This tax saving feature of the law is almost always available to estates, but not frequently available to trusts.
  • In many cases, real estate (even what used to be a personal residence) that is sold by the estate will result in losses that the heirs (beneficiaries) can use to reduce individual taxes.  For real estate, it is critical to obtain a date of death appraisal from a licensed appraiser.  The gain or, more frequently a loss, is computed using a date of death value rather than the decedent's purchase price. A valuation from a real estate agent might be free, but the IRS can challenge such a valuation.  This tax benefit is worth paying an appraiser!
  • If the person who passed away had a revocable trust, consider electing to combine the trust with the estate (IRC §645). This can provide a trust with benefits that are normally only available to an estate. This includes delayed requirements for using estimated taxes, using a fiscal year end, using higher exemption amount, etc.
  • Properly elect to allocate certain deductions to specific classes of income (Treasury Reg. §1.652(b)-3(b)). This clearly cannot be done with Form 1040. With the trust or estate you want to allocate indirect expenses to the classes of income that have the highest tax rates. Example, you would want to allocate indirect expenses to interest income, but not qualified dividends.
  • There may be advantages to electing to capitalize maintenance and other expenses related to real estate. Also, increase the basis of the real estate by certain closing costs (IRC §266). If there are high real estate commissions, this might create deductible losses that could benefit beneficiaries!
  • If you are not filing Form 706, consider making an election to deduct administrative expenses on Form 1041, and not Form 706. If you are filing both Form 1041 and Form 706 get professional advice to determine where you want to deduct the administrative expenses. Make sure you know what an administrative expense is.
  • If you have in "Complex" trust, determine whether you need to make an election for the 65 day rule. This is not an issue with a "Simple" trust. "Simple" and  "Complex" are technical terms. Unfortunately, "Simple" trusts can be complicated and "Complex" trusts can be simple to prepare.
  • Choose a year-end for the estate that is most beneficial. You do not need to go by the IRS notices that specifies your Federal ID Number.
  • Almost always capital gains are taxed to the trust or estate at high rates. The most common exception is when it is the final year of the trust or estate. An exception would be if the trust document gives the trustee power to treat capital gains as part of DNI.
  • If this is a trust, determine if it is a revocable trust or an irrevocable trust. This might have cost basis implications.
  • Review interest and dividends for US government interest and/or double exempt municipal income.  Allocate these items to beneficiaries or heirs on a K-1 attachment.
  • Only income and deductions that are subject to probate go on Form 1041 for an estate.
  • If one of the trust or estate assets is an interest in a partnership, has an IRC §754 elect been considered?
  • If tax exempt income is received, make sure to allocate the proper amount of indirect expenses to the exempt income.
  • If this is the first year of the trust or estate, consider consequences of capital gains treatments.
  • Is a distribution needed after year-end to move taxable income from the trust or estate to beneficiaries. If so, consider an IRC §663(b) election using the 65 day rule.
  • Along with capital gains, excess deductions are treated differently in the final year of a trust or estate.
  • Compute DNI, Distributable Net Income, or have the Form 1041 tax software do that for you.
  • Consider filing Form 56 to facilitate communications with the IRS if needed.
  • The deductibility of charitable deductions is different on an estate or trust income tax return than that for an individual income tax return. Review the trust or will. If the estate or trust cannot take a charitable deduction. Consider a distribution to beneficiaries so that they might be able to take a charitable contribution that the estate cannot take.
  • Is there a power of appointment in the document?  Does this change tax basis amounts or distribution percentages?
  • Form 1041 extensions are typically for 5 and a half months. (Form 1040 extensions are usually for 6 months.)
  • Obtain names, address and tax ID numbers of heirs and beneficiaries to be able to prepare Form 1041, Schedule K-1 for those that received a distribution.  If a beneficiary does not want to provide a Social Security Number or a Federal Tax Identification Number, make them complete form W-9 before they receive a distribution.
  • If there is an out of state beneficiary, determine if beneficiary withholding is required on the state tax return. If this is the last year of the estate or trust, this should be determined before year-end!
  • The above list includes only a portion of the concepts that should be considered when preparing Form 1041!

If you have questions about this, do not hesitate to contact us at 1-720-493-4804.  We serve clients all over the country. A large portion of my business is preparing tax returns and tax planning for trusts, estates and beneficiaries of trusts and estates.

Circular 230 Notice:

The information contained here are simplifications of complex subjects. We recommend that you talk to a CPA about this issue.

To ensure compliance with requirements imposed by the IRS, we inform you that (i) any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

US Estate Income Tax Return
US Estate Income Tax Return Instructions
Colorado Estate Income Tax Return
IRS Publication 559