- A simple trust pays out 100 percent of the net income earned by the trust to the beneficiaries named in the trust agreement. Form 1041 is similar in many respects to a personal income tax return Form 1040, but requires additional information to generate the Form K-1 that goes to the trust beneficiaries. Form K-1 informs trust beneficiaries of any reportable tax they need to claim on a personal income tax return Form 1040. Unless the trust agreement states otherwise, capital gains or losses on investment activity report on the trust Form 1041 and any taxes due pay from trust assets. Distributable net income taxes to the trust beneficiaries on the income share they received. The DNI taxable amount may be less than the actual distribution amount received by the beneficiaries, as offsets occur for allowable deductions such as trustee fees and expenses.
- A complex trust does not require that 100 percent of the earned trust income pay out to the trust beneficiaries. The trust may pay some portion of the income or none at all, depending on the terms stated in the trust agreement. If any income or principal pays out to trust beneficiaries they will receive a Form K-1. If a beneficiary does receive funds, there it is possible taxation for income and capital gains if any funds received were from the principal of the trust assets. If a beneficiary did not receive funds from the trust, the trust pays all tax on income and capital gains.
- Irrevocable charitable trusts, commonly known as split-interest trusts, file Internal Revenue Service Form 5227. Form 5227 is more complicated than Form 1041, as it covers multiple types of charitable trusts. The two most common are charitable lead trust where individuals receive income from the trust and the principal goes to charity and the end of the trust term, or a charitable remainder unitrust where trust income goes to an individual and then to charity at the end of the trust term. Unitrusts tax beneficiaries to the extent of the distribution they receive, so taxation to the beneficiary is typically a mix of income and capital gains.
- All irrevocable trusts must have a unique tax identification number as the trust itself is a taxpayer under the Internal Revenue Code. A trust tax identification number is obtainable and tax return forms and instructions are available on the Internal Revenue Service website. Trust tax returns are very complicated, and it is always prudent to seek the advice of a tax professional when preparing the returns as tax law constantly changes.
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