Let’s be real. Nobody thinks taxes are fun. And the more complicated an estate gets, the more difficult a tax return often becomes. That said, if you have a Trust as part of your Estate Plan, or if you’re a beneficiary receiving income from a Trust, there are a few things you should know about the IRS tax Form 1041 (also known as a Schedule K-1).
Learn everything there is to know about Schedule K-1s here, as we cover the ins and outs of this important tax form that’s required if you have a Trust that generates any sort of income throughout the tax year.
What is a Schedule K-1?
A Schedule K-1 is the official federal tax form that’s used to report earnings and losses when there is an investment in a partnership. In cases of estate planning, Schedule K-1s are used to report earned income from the Trust.
Why Do You Need to File Schedule K-1 (Form 1041)
Any time a beneficiary receives any income from Trust earnings throughout the year, a Schedule K-1 will report them to the IRS. K-1s are also used to report any deductions or credits that come from an estate or a Trust, too. In cases where there are multiple beneficiaries of a Trust, each one will have an individual Schedule K-1 filed annually to ensure proper taxes were paid.
Who is Responsible for Paying Income Tax for Estates or Trusts?
The short answer here is if a beneficiary receives income from a Trust throughout the year, they are responsible for paying the income tax on the earnings. If the Trust is the only entity that earns income, taxes would be paid for out of the estate. Either way, if there is any income earned at all, a Schedule K-1 Form 1041 is the official form to be used.
Types of Deductions that Can Lower The Estate’s Taxable Income
Nobody wants to pay any more taxes and they absolutely have to. Being smart about your deductions can ultimately help lower an estate’s taxable income overall. Some common deductions that people often use to offset an estate’s tax implications include:
Professional fees like accounting fees for tax preparation and other miscellaneous attorney or legal fees
Marital deductions when property passes to a surviving spouse
Court filing fees
Executor fees if the estate is paying the bill
Required distributions to beneficiaries
Losses during the administration of the estate
What is the Difference Between Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120S)
Form 1065 and Form 1120S are two different versions of Schedule K-1s, both used to report income earned by businesses. These are different from the Schedule K-1 Form 1041s that we’ve been discussing, which again, are the tax forms used to report earnings from a Trust.
Schedule K-1 (Form 1065)
A Form 1065 is used for businesses who are formed as partnerships. While the partnership itself files a Form 1065, individual partners are also provided with a Schedule K-1 Form 1065 too, which reports individual shares of income, credits, deductions or other various tax-related items.
Schedule K-1 (Form 1120S)
A Form 1120S is what S-Corporations use to file their taxes. After filing a federal tax return, the corporation would also need to send every shareholder a Schedule K-1 Form 1120S. This is what would be used to claim individual income, credits, deductions or other tax issues shareholders would be required to report.
When is the Estate Tax Year?
Occasionally, the estate tax year will vary from the calendar year. Most often, an estate calendar year will start on the actual date of the owner's death and typically end on December 31 of that same year.
That said, an Executor has the ability to file what’s known as an election, requesting that a fiscal year be followed. In this case, the tax year would end the last day of the month before the estate owner’s one year anniversary of his or her death.
How Can You Report Income from Schedule K-1
Even if you’ve prepared and filed your taxes on your own for years, you may want to consult with a CPA, Accountant or Financial Advisor before attempting to report income from a Schedule K-1. Or, you may also choose to use online tax software, which offers information to help you navigate the process.
What happens if you don’t file your K-1? Even if it’s through no fault of your own, for instance if you don’t receive your Schedule K-1 on time, if you aren’t going to be able to file on time, you must file for an extension. Failing to do so will likely result in (often hefty) penalties.
Taxes are never fun, but understanding your liability and the requirements surrounding how and what you must file is essential so you’re not creating a potentially expensive headache for yourself down the road. Start your Estate Plan today with Trust & Will to plan and prepare for everything the future has in store for you, even if it does involve taxes!