For federal income tax purposes, a trust or an estate is considered a separate legal entity. It is a pass-through entity, meaning that the trust or estate does not pay income tax. A Schedule K-1 is produced with Form 1041 for each beneficiary, showing each beneficiary his or her share of the income and deductions of the estate or trust.
Prior to completing Form 1041, the fiduciary computes the accounting income of the estate or trust, using the will or trust instrument and any related local law to arrive at the amount, if any, of income which is required to be distributed. This is crucial, because the deduction for income distribution is based on that amount.
The deduction for income distribution allowed to estates and trusts for any amounts paid, credited, or required to be distributed to the beneficiaries is limited to distributable net income (DNI). DNI is also used to arrive at how much of any amount paid, credited, or required to be distributed to a beneficiary would be included in the beneficiary’s gross income.
Any amounts that are income in respect of a decedent (IRD) must be taken into consideration when preparing Form 1041. The definition of income in respect of a decedent is income that a decedent was entitled to receive but which was not includible in the final income tax return of the decedent due to the method of accounting used by the decedent. Some of these items are: any accrued income of a decedent who used the cash method of accounting, income for which the decedent had a contingent claim at the time of death, deferred salary payments payable to the estate of the decedent, uncollected interest on U.S. savings bonds, and the part of a lump-sum distribution to the beneficiary of the decedent’s IRA equaling the balance in the IRA at the time of death.
Some deductions and credits that were not allowable on the final income tax return of the decedent, are allowed on Form 1041 if paid by the estate. These include the foreign tax credit, deductible taxes, business expenses, deductible interest, investment expenses, and percentage depletion.
Form 1041 can be very difficult to complete. For further information and clarification, see the instructions to Form 1041, or Publication 559, Survivors, Executors, and Administrators.
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