Alternatives to form 1041 for grantor trusts.

• Author: Hills, Marvin D.

Normally, a trust must file Form 1041, U.S. Income Tax Return for Estates and Trusts, each calendar year. However, for most grantor trusts, filing Form 1041 is optional. Described below are alternative methods of reporting and the situations when an alternative reporting method is available. This item also addresses concerns some people have expressed about using these alternatives, particularly with irrevocable grantor trusts (where the trust assets are not includible in the grantor's taxable estate).

When grantor trust status applies, either the grantor or a beneficiary is treated as the owner of the activity inside the trust for income tax purposes. In that case, the deemed owner must include the activity of the trust on his or her personal tax return (see Regs. Sec. 1.671-2(a)). Grantor trust status can apply to either a revocable or an irrevocable trust, and there can be multiple deemed owners of a single trust.

The general rule is that all grantor trusts must file a Form 1041, which contains only the trust's name, address, and tax identification number (TIN) (see Regs. Sec. 1.671-4(a)). The assets owned by the trust are normally titled so that the earnings are initially reported by the payor (i.e., the brokerage firm, partnership, or, in many cases, an S corporation, etc.) as being taxable to the trust. However, by filing the Form 1041, the trustee is in effect letting the IRS know that the items of income or deductions are instead reportable by the "deemed owner." The activity that is reportable by the deemed owner is summarized on a separate statement (a grantor tax information letter), which is attached to the otherwise blank Form 1041 when it is submitted to the IRS. However, there are two alternative reporting methods that allow some grantor trusts to avoid filing a Form 1041.

First Alternative

One alternative method allows the trustee of the trust to file Forms 1099 in lieu of a Form 1041 (see Regs. Sec. 1.671-4(b)(2)(iii)). In that case, the ownership of the assets themselves is listed in the normal way with the payor, so that income is initially reported as taxable to the trust. However, the taxability of that income is shifted to the deemed owner when the trustee prepares Forms 1099 showing the trust itself as the payor, and the deemed owner as the payee. As a practical matter, though, if there are multiple types of income (dividends, interest, rent, etc.) or multiple sale transactions, this method may not be any easier than...