Trust Accounting

Yes. The trust passes all income along. Bene's get K1s and pay the tax on the income.

Huh? 2007 is over. The trustee, if a complex trust not 'having' to distribute income, retained it, and the trust paid the tax. Now it's all principal (including unrealized gains/losses). Now, in 2008, it has three things to do, take the 2008 income, and distribute it or not (that's two) and distribute any principal.

It's a distribution of principal, if I read this right.

There is a requirement that the trustee be slapped with a white glove. This is contrary to correct bookkeeping. You go through the 1041 set and if income is distributed via K1, the beneficiaries pay the tax, and the trust, not. This question sounds like the trustee deciding to have the trust retain earnings (and therefore pay tax at the trust rates) but distribute principal to the bene's. I am not confused so much as I am shaking my head why one would do this. I know some kind soul might have a scenario for me that offers "but the K1 income to this beneficiary will have such and such an impact....". I don't claim to know it all, I am certain I don't. But such a scenario (regarding the trust) seems unlikely.

Joe

The 2007 returns weren't filed yet. The trustee took them to someone at H&R Block who made a mistake, and I'm working with another preparer to get it straightened out.

The current preparer wants to file the 1041 claiming all the trust's income for tax purposes, even though it passed through to the beneficiary (the surviving spouse). One problem was that the 1099 was reported on the beneficiary's SS# rather than on the trust's EID#. So that needs to be straightened out.

Now, trust distributions are reported on a K-1 rather than a 1099? Does that mean the trust can distribute depreciation as well as income to the beneficiary?

Thanks, that's what I was hoping. I'll look into it a bit more.

Nobody wants to do it. It's a matter of straightening out one mistake made by the payor of income that needs to be recognized, compounded by the mistakes of an H&R Block preparer.

This is the same matter I asked about a few weeks ago, when teh HRB preparer did the returns properly, and then did them again but giving the trust the beneficiary's income and the beneficiary the trust's income (the funds were distributed so the beneficiary should recognize it all in any case). The preparer determined that if the returns were prepared the right way the total tax would be about $20,000 more than if done the other way. It made no sense to me.

Now I discover that in doing the returns both ways, in the second scenario she included the same $100,000 of income on both returns and deducted it on neither.

Stu

[...]

And I remember getting confused when I tried to be helpful back in the earlier thread, too!

At the risk of stating the obvious, whether this is a simple or complex trust really needs to be straightened out. If a simple trust and all income is required to be distributed "currently", then I don't think it's too late to send out checks for 2007, and report the distributed, taxable income via K-1's. The actual constructive receipt by the beneficiaries does not have to happen prior to Dec 31st.

H&R Block is a large enough organization that there should be at least a few very knowledgeable and experienced people in the year-round or high-end offices, so it should be possible for the client to ask management to get someone else involved at a higher level if there is evidence that the preparation is being handled poorly. Block provides some basic guarantees on their work, so it is in their interest to get this handled properly.

-Mark Bole

...

IIRC, the fiduciary has 65 days from the end of the tax year to make payments or credits to the beneficiary and be counted as being paid or credited on the last day of that tax year.

To straighten this out definitely need to start w/ determining the actual terms of the trust and then go from there.

I know as trustee, how it works when one does it on time and actually makes the distributions; I have no idea what happens in a case where distributions aren't paid (nor taxes, either) and what would be the proper way in which to approach it.

Nice in theory, how well it will work in practice I don't know... :)

If OP were in a place like here, there is no such thing as a permanent or "high-end" H&RB office and I've no idea how one would get ahold of such an animal... :(

I see. I take it this is not a brokerage account? The trusts I've had any dealings with have their own EIN, and don't reference the beneficiary's SSN at all. (I just peeked at one such trust. The Trust document itself does not reference a SSN). How did this mixup occur?

Depreciation should first net against income (I assume you're talking rental property?) p42 of the instructions for 1041 discuss the K1, and it then refers to other rules regarding depreciation in excess of income. Not a simple matter. I'm not surprised H&R Block didn't get this right.

Joe

In this case the income was actually paid out to the beneficiary in

2007. And it was paid mistakenly under her SS#, for which she was given a 1099. That's part of the problem.

The trustee likes this particular preparer and has used her personally in the past. She switched from the preparer I originally suggested to her because H&R's price is lower.

Stu

I'm not sure how it happened. I think they just made a mistake and gave them the wrong number.

Turns out that what I thought of as the main problem wasn't depreciation. The Block preparer included the same income in both the 1040 and the 1041 and didn't deduct it from either - it was counted twice, and that resulted in additional tax of $20,000.

Stu

The 65-day election specifically applies to estates and complex trusts. I have looked in multiple places and found no such rule one way or the other for simple trusts.

One reliable book I have indicates that Section 652(a) of the tax code talks about gross income to the beneficiaries "whether distributed or not", meaning the accounting for the tax year can be completed before actually distributing the income (otherwise, how would you know how much to distribute?)

On to the larger issue, Stu seems to have found the real problem, namely not taking the distribution deduction on the trust tax return. As a pass-through entity, normally one would not expect a simple trust to show any taxable income to the trust itself. (But I'm sure there are exceptions I haven't run into, I don't claim to be a trust expert by any means).

-Mark Bole

I agree with the points you make here, Mark. Earlier you asked Stu to confirm whether the trust was simple or complex. I agree that's the first data point needed. Next, the trust should state the terms under which distributions are made. I cannot find it, but am thinking that a simple trust had an end of February (for calendar year trusts) distribution requirement. Of course, a year end distribution by any [mutual] funds would be known in time for a 12/31 distribution to the beneficiary. I imagine trustees have a bit of a scramble to perform the task in the first few weeks of the year.

Back to Stu's issue. A simple trust should be all pass-thru as you suggest. a complex trust should only pay tax on what's actually retained. The tax preparer(s) and trustee(s) need to get their act(s) together. This can be an expensive mistake.

Joe

joetaxpayer wrote: ...

I don't know where it comes from either, specifically, now that I went back and reread the Pub which does specifically not include simple trusts. The preparer I use for the trust of which I am trustee also believes and has always operated on the basis of distributions do have to be made within a window (I don't recall now for sure whether he thinks we have the extra five days or not). It is indeed, a bit of a scramble because supporting documentation isn't always available even from mutual funds at year end as revised 1099's straggle in and other investments are much less prompt than they in getting year end data provided.

Not that any of this has any real bearing on Stu's real problem but it will be interesting to hopefully hear how it all works out in the end... :)

I'm confused. Your first post ("But take a slightly different situation. The trust does not distribute the income in the current year, but retains it") says that the trust did not make any distributions but retained the profits, so the income should not have been on the beneficiaries' 1040.

What is the penalty is a trust is required to make a distribution but does not? Is it 50% of the amount that should have been distributed?

If for example the trust had profits in 2006 and was not required to make distributions and did not, it paid taxes on the profits at the higher trust rates. So if the trust distributes the profits in 2007, will the beneficiary have to pay taxes on the 2007 1040, and will the trust get to take a deduction on the amount distributed? I think the answers are no, no. How does one report the return of capital on the

1041 and 1040?

And say the trust made 100k in 2006 and 70k in 2007. If in 2007 it distributes 80k, how much of that 80k is taxable on the beneficiaires

1040? I would imagine 70k is taxable, and 10k is a return of capital, with 90k of capital remaining to be returned.

If I said that then must have been slipped something before I posted that. The trust's income was distributed to the beneficiary when paid, and it was mistakenly listed by the payor under the beneficiary's social security number on the 1099.

The tax preparer included the income on the beneficary's tax return because that's how it was listed on the 1099, and didn't file a trust return. When I told her the income actually belonged to the trust, she redid the return, saying that resulted in an additional $20,000 in tax. It didn't make sense to me.

Stu

But the 1099 was a mistake, and should be fixed. I know (?) you can't go back a change from Married filing Joint to Individual after the fact just because you decide it will save money. But in this case, a mistake was made, not a trivial one. Once the 1099 is corrected, the 1041 and K-1 may need fining as well, but if the trust is 'simple', it should zero out each year, and the beneficiary should be happy to pay tax at her lower rate. And no offense, she should find a competent trustee and tax preparer. And the 1099-cutter as well, who was that?

Really, this shouldn't be this complicated. The first time, it's new, but the process is usually pretty straightforward.

Joe