Form 1041 Grantor Trust, Optional Method 1

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Ken Reckers
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Form 1041 Grantor Trust, Optional Method 1

Post by Ken Reckers » Sat Aug 11, 2007 8:26 am

Does anyone have any experience in using "Optional Method 1" instead of filing Form 1041 for a Grantor Type Trust? (Legal advice has determined that the trust in question is a grantor trust.) As I understand it, with Optional Method 1, you include the trust income on your own 1040 and use your own SS#.

I don't see any advantage in choosing "Optional Method 2," which to me looks the same as 1, except with 2 you would use the trust tax ID# instead of your own, and then complete extra paperwork (1099's). Am I right that Optional Method 1 makes more sense than 2?

Thanks.

"Ken"

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Post by FinanceGeek » Sat Aug 11, 2007 4:43 pm

I'd ask this over at fairmark - they have a really good tax oriented forum there.

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dcnut
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Post by dcnut » Sat Aug 11, 2007 5:25 pm

I have filed tax returns for several 'grantor-type' trusts over the years -- for my mother-in-law and my parents. In all cases, I have chosen to get an employer identification number (EIN) for the trust and to utilize the 'regular' method in which you fill-out the front page of form 1041 and then attach a sheet of paper showing all the income that will be reported on the grantor's 1040. This has been quite painless, as you only need to enter very little information on form 1041. The grantor simply reports all the income just as if no trust existed.

There is a big advantage of having an EIN, in my opinion. When the grantor dies, you do not need to re-register all the investments in the trust with a new EIN. The grantor's SSN cannot be used after his or her death. You will be busy enough during this very trying time without having to worry about getting an EIN and re-registering all the investments.

Glenn

Ken Reckers
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Post by Ken Reckers » Sun Aug 12, 2007 2:14 am

Thanks for the fairmark tip.

Glenn, Thanks for explaining the "regular way." This clarifies the 1041 instructions, and it now looks much more painless than I imagined. I see your advantage in obtaining the EIN in advance.

Here is my paraphrase of what a "grantor type trust" is.

A "grantor type trust" is a trust that is a *legal* entity, but *not* a separate taxable entity.

This can be the case when the owner is the also the trustee, and has complete control over it, to withdraw the entire amount at any time for any reason, for his own benefit.

This means the trust income is taxed at the owner's rates, not trust rates, right?

Because it's not a separate taxable entity, there is a "regular" way to file, which is a minimalistic 1041, plus attachment, plus owner's 1040. Or optionally, just file on the owner's 1040 using "optional method 1," as if it wasn't even a trust at all. (Not sure at all why "optional method 2" would be used.)

I can't readily find an official definition of "grantor." I guess it's the person whose assets were placed in the trust in the first place.

But as I understand it, the "owner" of a "grantor type trust" does not have to be the grantor himself. It could be another person who is substantial owner of the trust (under section 678), as for example when the owner is also the trustee, and has complete control over it, to withdraw the entire amount at any time for any reason, for his own benefit.

Am I understanding this correctly? (At least mostly correctly?)

Thanks for reading this obscure (to me) stuff.

"Ken"

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LH2004
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Post by LH2004 » Sun Aug 12, 2007 3:48 am

Ken Reckers wrote:A "grantor type trust" is a trust that is a *legal* entity, but *not* a separate taxable entity.
Yes, in principle. It's a trust, which is a real trust for (most) trust-law purposes, but which is disregarded for tax purposes. Whether any trust is a legal entity at all depends somewhat on what you mean by "legal entity," which isn't a very well-defined term.

The standard term is just "grantor trust."
This can be the case when the owner is the also the trustee, and has complete control over it, to withdraw the entire amount at any time for any reason, for his own benefit.
Yes, that's one way, and the prototypical example: it's clear why the tax law doesn't treat that kind of trust differently from the owner just owning the property directly. (If you're thinking about why the law is the way it is, it may be helpful to keep in mind that, while the trust tax rates are very unfavorable now, once upon a time being taxed as a trust was a good thing.)

There are many other conditions that can cause a trust to be a grantor trust, many of which are less obviously sensible.
This means the trust income is taxed at the owner's rates, not trust rates, right?
Right.
I can't readily find an official definition of "grantor." I guess it's the person whose assets were placed in the trust in the first place.
Yes, that's the meaning in non-tax law: the 3 parties involved in the trust are the grantor, who gives something to the trustee, to be held for the benefit of the beneficiary.
But as I understand it, the "owner" of a "grantor type trust" does not have to be the grantor himself. It could be another person who is substantial owner of the trust (under section 678), as for example when the owner is also the trustee, and has complete control over it, to withdraw the entire amount at any time for any reason, for his own benefit.
Yes. It can also be a completely unrelated party to whom the original grantor's rights were transferred. And, again, a grantor trust does not need to be revocable, so those rights can be more limited.

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Post by JDCPAEsq » Sun Aug 12, 2007 8:16 am

dcnut wrote:There is a big advantage of having an EIN, in my opinion. When the grantor dies, you do not need to re-register all the investments in the trust with a new EIN. The grantor's SSN cannot be used after his or her death. You will be busy enough during this very trying time without having to worry about getting an EIN and re-registering all the investments.

Glenn
This is usually incorrect. On the death of the grantor the trust will become irrevocable and a new tax ID number is required for the newly irrevocable trust.
John

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dcnut
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Post by dcnut » Sun Aug 12, 2007 9:34 am

JDCPAEsq wrote:
dcnut wrote:There is a big advantage of having an EIN, in my opinion. When the grantor dies, you do not need to re-register all the investments in the trust with a new EIN. The grantor's SSN cannot be used after his or her death. You will be busy enough during this very trying time without having to worry about getting an EIN and re-registering all the investments.

Glenn
This is usually incorrect. On the death of the grantor the trust will become irrevocable and a new tax ID number is required for the newly irrevocable trust.
John
Yes, a grantor trust will become irrevocable upon the death of the grantor.
If the former grantor trust had an EIN assigned to it, however, the trustee does NOT need to get a new EIN upon the death of the grantor. This is the point I was making. I have been through this situation on two occasions, and have been under the guidance of an estate attorney.

Glenn

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dcnut
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Post by dcnut » Sun Aug 12, 2007 12:28 pm

Yes, a grantor trust will become irrevocable upon the death of the grantor.
If the former grantor trust had an EIN assigned to it, however, the trustee does NOT need to get a new EIN upon the death of the grantor. This is the point I was making. I have been through this situation on two occasions, and have been under the guidance of an estate attorney.
I wish to add a few more thoughts to the above. A grantor trust not only becomes irrevocable upon the grantor's death, but it is no longer a grantor trust either. It will become either a 'simple' trust, or a 'complex' trust, depending on the trust provisions.

I assume that the original poster (Ken) is dealing with a grantor trust in which the trustee is a different person than the grantor. Only in this case will the IRS allow an EIN to be assigned to the trust.

The most-common grantor trust is the revocable living trust (RLT) in which the trustee and grantor are one and the same person. In this case, the trust must use the grantor's SSN, and no Form 1041 or other special reporting method is necessary.

Glenn

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Estate Attorneys may differ...

Post by JDCPAEsq » Sun Aug 12, 2007 2:36 pm


Yes, a grantor trust will become irrevocable upon the death of the grantor.
If the former grantor trust had an EIN assigned to it, however, the trustee does NOT need to get a new EIN upon the death of the grantor. This is the point I was making. I have been through this situation on two occasions, and have been under the guidance of an estate attorney.

Glenn
I understand you may have been told that by an estate attorney but, as one myself, you should know that to properly administer the grantor trust along with the succeeding irrevocable trust, either simple or complex, a new EIN number is required.
John

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dcnut
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Re: Estate Attorneys may differ...

Post by dcnut » Sun Aug 12, 2007 3:32 pm

JDCPAEsq wrote:
I understand you may have been told that by an estate attorney but, as one myself, you should know that to properly administer the grantor trust along with the succeeding irrevocable trust, either simple or complex, a new EIN number is required.
John
Perhaps they do things differently here in Illinois. We will just have to agree to disagree on this point. Certainly to me, at least, it is much more logical to keep the same EIN attached to a trust during its entire lifetime. The IRS has not complained either.

Glenn

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Tax Planning

Post by JDCPAEsq » Sun Aug 12, 2007 3:57 pm

Glenn - Do as you like, but you're throwing money down the drain not getting a new EIN for the succeeding trust. You are losing what can become significant tax advantages by adopting a new fiscal year for the following trust and timing distributions to that trust or multiple trusts. You are guaranteed tax savings by splitting income between two or more trusts rather than one. In administering trusts, I have always felt we often earned our keep by utilizing this type of tax planning at the death of the grantor. Failing to do so could subject a trustee to surchange.
John

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Re: Tax Planning

Post by dcnut » Sun Aug 12, 2007 7:27 pm

JDCPAEsq wrote:Glenn - Do as you like, but you're throwing money down the drain not getting a new EIN for the succeeding trust. You are losing what can become significant tax advantages by adopting a new fiscal year for the following trust and timing distributions to that trust or multiple trusts. You are guaranteed tax savings by splitting income between two or more trusts rather than one. In administering trusts, I have always felt we often earned our keep by utilizing this type of tax planning at the death of the grantor. Failing to do so could subject a trustee to surchange.
John
Thank you, John, for the explanation. I will ask my attorney about this sometime, but I suspect that the die has already been cast as these events are several years in the past. It seems like your method involves much more complexity, however, so I am not sure we made the wrong decision.

Glenn

Ken Reckers
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Post by Ken Reckers » Mon Aug 13, 2007 12:24 am

These are very helpful and clarifying responses, even if some of the (controversial) examples are different from my concern. Thank you very kindly.

But they do raise a new question of my own:

Parent P has children C1 and C2.

My concern is not P's trust T.

P has died already. Pursuant to T, trusts T1 and T2 are created for benefit of C1 and C2, respectively.

C1 is the trustee of T1 and has sole and complete power to withdraw the entire amount for himself. Ditto for C2.

(Apparently, the reason is not for tax purposes, but to protect the amounts from creditors, spouses, etc.)

Can't T1 be a grantor type trust?

"Ken"

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LH2004
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Post by LH2004 » Mon Aug 13, 2007 2:47 am

Ken Reckers wrote:C1 is the trustee of T1 and has sole and complete power to withdraw the entire amount for himself. Ditto for C2.

(Apparently, the reason is not for tax purposes, but to protect the amounts from creditors, spouses, etc.)

Can't T1 be a grantor type trust?
Yes, but I don't think I'm understanding the facts here. Giving C1 the power to withdraw assets from T1 isn't going to protect those assets from C1's creditors.

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Grantor Trust

Post by JDCPAEsq » Mon Aug 13, 2007 7:50 am

Yes, the trust you describe is a grantor trust which will have all the usual advantages of a revocable grantor-type trust. It will not protect the assets from the beneficiary's creditors.
John

Ken Reckers
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Post by Ken Reckers » Mon Aug 13, 2007 1:24 pm

Oh. I'm the one who's not understanding the facts. Glad to hear it is a grantor trust. But I incorrectly assumed that protection from creditors was the reason it was set up.

I'm satisfied now from a practical point of view. But from the theoretical viewpoint, I'm still puzzled. Why give the assets to T1 fbo C1 with C1 as trustee, instead of simply C1?

"Ken"

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Various Reasons

Post by JDCPAEsq » Mon Aug 13, 2007 1:42 pm

Trusts are created with terms such as you describe for various reasons. First of all it provides a mechanism for managing the assets. You can usually appoint a professional trustee to act with you. Also, it provides for the disposition of the assets upon your subsequent death. Are you sure you have the absolute right to invade principal and terminate the trust, or is it the power to invade principal for yourself subject to an ascertainable standard such as health support and maintenance? Such a trust may also not be subject to division with a spouse in the case of divorce and would also provide a mechanism for your protection in the case of incompetency. If the trust is as broad as you describe, it in effect allows you to decide whether or not you wish it to continue in whole or in part. Much better than a mandated outright distribution to you.
John

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Creditors

Post by JDCPAEsq » Mon Aug 13, 2007 1:47 pm

I should have noted in the previous posts that, with the appropriate language limiting your power to invade principal, there would be protection from creditors. Perhaps the trust instrument contains this language and you are not aware of it.
John

Ken Reckers
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Post by Ken Reckers » Mon Aug 13, 2007 10:43 pm

You are right. When I read more carefully, there is language about education, health, support. Also, C1's best interests. Provisions in case of disability. I am somewhat embarrassed about my imprecision.

Thank you for your generosity in terms of time and expertise in responding to my naive questions.

"Ken"

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Post by JDCPAEsq » Tue Aug 14, 2007 8:09 am

Ken - Don't be embarassed by overlooking this language in the trust. Many lawyers do the same.
John

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