Before my dad died 10+ years ago, he created a trust with me and my step-sibling as beneficiaries. My stepmother would receive all the earnings from the trust (and has done so), but the principal would go to me and my step-sibling upon my stepmother’s death. I never expected to see that any of that money, because my stepmother is roughly my age.
It turns out my step-sibling is desperate for cash, so my stepmother is dissolving the trust. Specified percentages of the principal will be distributed to me and my step-sibling. I have agreed to sign the dissolution agreement, because (I assume) I have nothing to lose.
The trustee is also my stepmother’s attorney. He is cagey, so it’s hard to pin him down on details. Based on research, I think I understand the following, but I would like your confirmations and corrections:
At year's end, the trustee will file a Schedule K-1 (Form 1041), but any interest/dividends/income it reports will have nothing to do with me, because (1) those amounts have already been paid to my stepmother or (2) the trust itself has already paid the appropriate taxes. Yes/no/sorta?
Although I will receive a chunk of the principal, a 1099 will not be used to report that distributon, because I can't "earn" what is already my asset, which I inherited at my father's death. Yes/no/sorta?
So without my playing any games, the IRS will receive no documentation that I received any share of the principal? As you might guess, this is the part I care most about.
K-1 does have to do with you. It can help or hurt you. They send you the form which is your portion, and you put it on your taxes. If you use an online tax form, it should be easy.
No, you don’t get a 1099 if it qualifies as an inheritance.
When I inherited a little money, the IRS knew about it only from the front end, but my name was indeed part of the tax forms that have to be submitted for the estate. But, none of the inheritance I received was reported to the IRS - only the K1 mattered at all.
It’s kind of confusing, but my understanding is that the time is for the taxes on the estate to be hashed out, both federal and state, and then the dispersals can be made. It is unknown how quickly such a trust can be dissolved, if it was just an inheritance, it would be from 12 to 18 months at a minimum. But hopefully, the trust is self-contained enough it might be quicker.
And if this relates to college at all, the money you get would show up as an asset that is liquid (cash in the bank or stocks and bonds you might buy) or less so (pay off your mortgage or other debts). So if you have a lot of debt, that colleges would not care about at all, paying off debt is the best way to “hide” the money.
Thank you. My plan is to pay off as much debt as possible. The trick is knowing whether I have to keep a chunk of the money visible as an asset so that it’s available to pay taxes on the distribution (and if so, how much).
The K-1 will show what portion of the 2015 trust income is “yours” and reportable on your own tax return. Generally speaking trusts pay more income taxes on income retained by the trust than the beneficiaries would pay if the income were paid out to them and reported on their 1040 via a trust K-1. The principal (assets) of the trust do not represent income and should not be reported as income on the K-1, which as posted above is all that matters for your 1040. The only thing different about this K-1 should be that the box that says “this is the final K-1 from a trust which is being dissolved/terminated” or words to that effect.
quote those amounts have already been paid to my stepmother or (2) the trust itself has already paid the appropriate taxes.
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It’s (1). Income is distributed to your stepmother. Usually income from a trust is distributed to individuals since income tax on trust is higher. Since the trust is dissolved before the death of your stepmother, it will be considered as gift from your stepmother not your father and taxed accordingly. Gift tax is paid by the giver not recipients. Not sure about state inheritance tax.
I don’t know what form one gets for inheritance. K-1 reports income from trust and I would think it goes to stepmother not you. Not totally sure.
OP, I’ve only glanced at the answers here, but it occurs to me it might be worthwhile to hire your own attorney to make sure that what your step-mother’s “cagey” attorney tells you and does is correct.
Part of the reason I am asking here is to see if I really need an attorney. My step-mother’s attorney is actually one of the most respected in his community, and I am confident that everything he does is correct. I describe him as cagey in the sense that, since I am not his client, he gives me “need-to-know” information, and only when I ask the right questions. So when I ask him things like, “Exactly what documentation will be filed with the IRS?” he says things like, “That will be determined by the accountant when we file.” Which I suppose is an honest answer.
@WasatchWriter, I don’t think so. Inheritance is not a taxable event for you. Taxes will be paid by the estate and the rest will be distributed. A lot depends on the state tho. We tried to do the same a few years ago. Not because we needed the money but the bank who is the trustee became a headache to deal with.
You’ll only need an hour or two of a lawyer’s time, to review documents that exist and actions that your stepmother’s attorney takes, to make sure they’re legal and in keeping with what the documents say. I think it’s a useful investment.
Interesting situation. I’m surprised the trust allows for early dissolution but since the the action is a huge benefit to you (and a big sacrifice by step-mother) there would be no reason for you to oppose the plan. As a beneficiary of the trust I believe the trustee is required to provide you (at least in some states) with a detailed accounting of the trust and how the assets have been handled. If you know already how much you should be receiving and you are confident in the integrity of all involved you might not need your own attorney.
You should not owe any tax on the inheritance as long as the amount you will receive is exactly the same as it was on the day your dad died. However when the chunk of money enters your bank the IRS will be notified if it is in excess of $10,000. Most likely nothing will happen, but there is a remote possibility you would be audited to determine the source of the windfall. I would consider hiring an enrolled agent tax preparer to handle your taxes for the year in which you receive the payment. Enrolled agents are authorized to represent you before the IRS if any questions arise.
Interesting point. It’s highly likely that the trust will have capital gains if the fund is liquidated before distribution. Who is entitled to capital gains in a terminal trust? Is there a way to distribute the assets without liquidating to avoid the capital gains tax? Would it be better if OP agrees to dissolve if they distribute before liquidating? Whoever needs money can sell later.
Your step-mother’s attorney might be the most reputable, honest, brilliant lawyer in the history of the world, but he is not YOUR lawyer. He has no obligation to provide you any services or to protect your interests in any way, particularly if your interests conflict with the wishes of his client. You should definitely speak to your own attorney, it wouldn’t cost you very much.
Unless the trust owns illiquid assets like real estate, there is no need to realize capital gains by selling assets before distribution. If the trust owns 100 shares of Apple, then the beneficiaries can get 50 shares of Apple transferred to each of their brokerage accounts. The only thing to remember is that the basis of the shares (generally) will not be the price on the date of transfer, but the price on the date of death of the grantor of the trust.
The bottom line: you are one of two beneficiaries of the trust. The trustee has to act as a fiduciary to protect your and the other B’s best interests. That is the highest duty found in the law. At the very least you are entitled to any and all information relating to the trust. Otherwise, you are entitled to an “accounting.”
I’m glad you are engaging your own attorney. Have you received any K-1s in the past? Any financial information about the trust? Don’t be pressured into signing anything to decant or terminate the trust before you have reviewed the documents with your own attorney.
(1) will the Trust distribute assets in kind or liquidate then distribute funds – basis of the assets will be important because a distribution of assets in kind may carry tax liabilities upon sale.
(2) if you are getting in-kind assets from the Trust, you’ll get carryover basis from whenever the assets were transferred to the Trust (depends on whether it was during your father’s lifetime) and it will carry over to you
(3) so, not all assets are “equal” in value if you account for unrealized gains