Farr Law Firm Now Filing Tax Returns for Our Clients

Q. My sister and her husband set up an irrevocable asset protection trust with your firm as part of their estate planning. She was trying to explain this type of trust to me, but I still don’t understand, so I signed up for one of your upcoming seminars. She is a very prepared person and since we are getting close to tax time, she is also trying to figure out how the trust’s income is taxed if someone passes away, what forms are used to file, and where someone might go to file them. When she mentioned income tax returns for irrevocable grantor trusts, including the grantor trust statement/letter to her friend who is an accountant, she found that her accountant doesn’t deal with these types of trust tax returns, and so far she has called around and found it impossible to find an accountant willing to take her on as a new client right at the beginning of tax season. Does your firm by any chance provide any of these tax preparation services? Thanks for your help!

A. I have also heard from many clients that a lot of accountants don’t handle tax returns for grantor trusts, so I’m so glad you asked this very timely question. I am very happy to announce that, effective immediately with the 2021 tax filing season, the Farr Law Firm is now offering to prepare these types of tax returns, and many others, for our clients and for others who may need this service. More information about this later, but first let’s start with a refresher about what a grantor trust is, and then I’ll tell you how we can help when it comes to preparing the necessary tax returns.

What is a Grantor Trust?

The Internal Revenue Service (IRS) generally defines a grantor trust as one in which the person who created the trust (the “grantor”) retains some control or use over the assets of the trust, which results in all taxable income earned by the trust being taxed to the grantor as the creator of the trust. All revocable trusts are grantor trusts while the settlors are alive but immediately turn into irrevocable trusts when the settlors die, because obviously a dead settlor can no longer revoke a trust. Most irrevocable trusts that we prepare for our clients are also grantor trusts.

Typically an irrevocable trust in which the grantor retains certain ownership rights or certain levels of control over assets is a grantor trust. Though these trusts are irrevocable — meaning simply that the trust cannot be revoked unilaterally by the creator of the trust — if the grantor retains certain control over the disposition of the assets, even indirectly, such as the ability to change the beneficiaries and change trustees (powers typically contained in our Living Trust Plus® asset protection trust), it is treated by the IRS as an irrevocable grantor trust, which is the desired goal. Contrary to the belief of many individuals and even many attorneys and accountants, the term irrevocable does not mean that the creator cannot make changes to the trust. This is unfortunately a very common misconception held by members of the general public and by many Virginia Estate Planning Lawyers, Maryland Estate Planning Lawyers, and DC Estate Planning Lawyers, and even by many accountants.

Reporting Irrevocable Trusts to the IRS

There are several methods by which irrevocable trusts can be reported to the IRS during tax time, but we recommend one specific method, which is the simplest method that financial institutions recognize. (Keep in mind that revocable trusts, even though they are grantor trusts, do not go through this; with a revocable trust, the seller simply continues to file the 1040 that they always have.)

With an irrevocable grantor trusts, the grantor is responsible for paying all income tax on any earnings and is entitled to claim all deductions and credits on his or her tax return. If an irrevocable trust has its own tax ID number, which all of ours do, then the IRS requires the trust to file its own income tax return, which is IRS form 1041. During the lifetime of the grantor, any interest, dividends, or realized gains on the assets of the trust are taxable on the grantor’s 1040 individual income tax return. Along with the 1041 and the 1040, a “grantor trust statement,” sometimes called a “grantor trust letter,” is filed, showing the income received by the trust and the deductions and credits attributable to the trust, and explaining that these are all passed through to the grantor’s 1040 individual tax return.

After the grantor’s death, another set of tax rules intentionally makes it so that the trust assets are considered part of the decedent’s estate and therefore receive a full step-up in basis for capital gains tax purposes. Also, if the primary residence owned by the irrevocable grantor trust is sold by the trust during the grantor’s lifetime, the grantor is entitled to take $250,000 capital gains exclusion in connection with the sale, assuming all other requirements for that exclusion are met.

IRS Form 1041 is also called a “fiduciary” return, because you file it in your capacity as trustee of a trust or executor of a decedent’s estate. A fiduciary is someone who is entrusted with someone else’s money and has a legal duty to act honestly and in the best interests of the trust or estate. A 1041 for a trust must be filed every year that the trust receives taxable income. A 1041 for a decedent’s estate must be filed every year that the estate remains open with income-producing assets.

Here is a quick look at the type of tax returns that the Farr Law Firm now offers to prepare for our clients, along with a brief description of each type of tax return:

Form 1041 Irrevocable Trust Income Tax Return and Grantor Trust Statement

The Form 1041 on its face appears very similar to the personal income tax return, Form 1040, that we all file every April 15. However, the Form 1041 that is filed for an irrevocable grantor trust looks very different than a 1041 for an irrevocable non-grantor trust, as there will be no tax or income figures calculated on the 1041 itself.

Because of this difference, these trust tax returns are more complicated to file than a typical trust tax return, and not all tax software allows the tax preparer the ability to electronically file these types of returns.

Because of these difficulties, our firm is now offering to prepare these 1041 tax returns along with the  grantor trust statements, and we are able to electronically file these returns so that you will get a faster refund than if you had to manually file.

For most clients, if you decide to use our firm to prepare the 1041 and grantor trust statement, you will also want our firm to prepare and file your 1040 each year, because all three of these documents are tightly interconnected.

  • Our irrevocable grantor trusts must generally file a 1041 for each taxable year where the trust has at least $600 in income. However, the 1041 for an irrevocable grantor trust is purely informational (here is a sample on our website), as an irrevocable grantor trust does not pay its own taxes; instead, as explained above, the creator of the trust, as the grantor, reports and pays all items of income and claims all allowable deductions and credits on his or her own Form 1040 Individual Income Tax Return.
  • Along with 1041 for the irrevocable grantor trust, you file a Grantor Trust Statement – and a copy of the Grantor Trust Statement also gets attached to your personal 1040 .
  • The grantor, and not the trust, is responsible for paying all taxes, as they are reported on the 1040 via the grantor trust statement, and are therefore liabilities of the grantor, and not the trust. This is generally a good thing, because it is a potential way for the grantor to divest himself or herself of additional non-trust assets, which is the goal of these asset protection trusts in the first place.

Form 1041 Estate Income Tax Return

  • After the death of the grantor, the trustee of a decedent’s trust and the executor of a decedent’s estate (typically the same person), is responsible for filing a Form 1041 for the estate.
  • The Farr Law Firm handles all types of trust and estate administration after an individual’s death,  to file these estate and trust tax returns after death.

Where Can You Go to File these Tax Returns?

Your sister is correct in that most accountants don’t deal with these types of tax returns regularly. At the Farr Law Firm, we are now offering to prepare tax returns for our clients, including 1041 income tax returns for irrevocable grantor trusts (including the grantor trust statement) and 1040s, along with 706 estate tax returns and 709 gift tax returns, as will be discussed in today’s Critter Corner article. No-cost initial tax consultations are being offered, so be sure to call the office to schedule your consultation as soon as possible, as appointment slots are limited.

Tax Return Preparation Fairfax: 703-691-1888
Tax Return Preparation Fredericksburg: 540-479-1435
Tax Return Preparation Rockville: 301-519-8041
Tax Return Preparation DC: 202-587-2797

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About Renee Eder

Renee Eder is the Director of Public Relations for the Farr Law Firm, and gives the voice to the Critters of Critter Corner. Renee’s poodle, Penny, is an official comfort dog who she and her children bring to visit with seniors who are in the early stages of dementia at a local senior home once a month.

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