Form 1041 – U.S Income Tax Return for an Estate or Trust is filed by the fiduciary of an estate or trust and it is due on April 15th for calendar year returns. The Form 1041 is a tax return wherein the entity actually reports and pays its income taxes. However, it is also a return where such an entity may deduct certain income items from taxable income because that income is being reported on the income tax return(s) of the beneficiaries of the estate or trust. As a result, Form 1041 has characteristics of a return where a taxpayer reports and pays income taxes (Form 1040 and Form 1120) and a return where the reportable income, deductions and credits are passed through to other taxpayers (Form 1065 and Form 1120S).
The Form 1041 filing threshold for any domestic estate is gross income of $600 or more, or when a beneficiary is a resident alien. The Form 1041 filing threshold for a trust is when it has any taxable income for the year, gross income of $600 or more, or a beneficiary who is a resident alien.
Creating a basic return for an estate or trust is done in the Business Program of Keystone Tax Solutions Pro by following the steps below. To assist in your preparation of a Form 1041 tax return, you should review the Instructions for Form 1041 – US Income Tax Return for Estates and Trusts. This publication contains line by line instructions detailing the transactions that need to be entered for each line of the 1041 return.
An Estate or Trust return has three basic areas that may need to be completed. Specifically, the preparer needs to address each of the following areas:
- Enter basic information about the Estate or Trust into the return (Steps 1- 8);
- Enter the various income and deductions (credits) items to determine taxable income for the entity and when applicable determine items to be distributed to the individual beneficiaries (Steps 7-18); and
- When applicable enter the information on the K-1 for the individual beneficiaries (Steps 19-22).
Step 1 – Select Business from the Main Menu of Keystone Tax Solutions Pro. Then select 1041 – Estates and Trusts.
Step 2 – Enter the EIN of the Estate or Trust and press Enter. A question will appear asking if you want to create a new return, select YES.
Step 3 – Form 1041– Estate or Trust Information Menu – Enter the Name of the Estate or Trust, Date Created and the Address for the Estate or Trust and then select OK.
Step 4 – Name & Address Menu – The information that you have entered will be displayed in this menu. Enter the Name, Social Security Number, Title and Contact Phone Number for the Fiduciary Signing the Return for this estate or trust. The fiduciary is the individual that is responsible for the filing of the tax return and would be the executor or personal representative for an estate or a trustee or their designee in the case of a trust. This information is required and must be entered in order to electronically file the return. From this menu you may also enter an optional e-mail address for correspondence from the IRS to the trust or estate. Exit this menu to be taken to the Heading Information Menu.
Step 5 – Heading Information Menu – At this menu the user can enter the Fiscal Year information for any estate or trust that does not operate on a calendar year. Here you should enter the beginning and ending dates of the fiscal year. Since most estates and many trusts operate on a calendar year, no entry would be made in this field for any calendar year reporting estate or trust. If a entity has a short year only because it was created earlier in the calendar year, it would still operate as a Calendar Year entity if it’s year ends on December 31. Only fiscal year entities whose year ends on the end of a month other than December 31would make an entry in this Fiscal Year menu. Improperly entering dates may cause returns to reject because it’s tax reporting period on the return would be different than the IRS’ records.
If the return is for a short tax year (less than 12 months) and is also a Final Return, fill in the Fiscal Year information and use the most current Form 1041 to file this return. It is not uncommon for an estate or trust to have a short tax year when they file the final tax return for an entity. Accordingly, when an estate (or trust) has a final tax year of less than 12 months that begins and ends in the same year, that years Form 1041 may not yet be available from the IRS by the time the estate or trust is required to file its final tax return. As a result, the estate (or trust) should file the most current Form 1041 which has been issued by the IRS (which may be the previous year Form 1041). However, the estate or trust must identify the short tax year in the Fiscal Year field on Form 1041, incorporate any tax law changes that are effective for that tax year, and mark the return as a Final Return in Step 6.
Step 6 – Heading Information Menu – Other Information – From this Heading Information Menu you will next select #3 – Other Information. In this menu, the user must first identify the type of entity that is filing the Form 1041. Under Question 1, the user will select the type of entity that is the subject of the return from a list of entities that includes domestic estates and different types of trusts. Depending upon the type of entity, there is a series of questions that will then be answered on this menu, as applicable. Specifically, if the entity is a trust the user must address those questions that relate only to trusts. If the entity is a Grantor Trust it should follow the requirements that are unique to Grantor Trusts. A Grantor Trust is a trust under applicable state law that isn’t recognized as a separate taxable entity for income tax purposes because the grantor or other substantial owners have not relinquished complete dominion and control over the trust. See: Form 1041 – Grantor Trusts.
It is also on this Other Information Menu where a user will indicate if the Form 1041 is either an Initial Return or Final Return. Marking the return as a Final Return has particular significance when filing a Form 1041, since certain deductions and losses can only be distributed to a beneficiary on a Final Return. If you are filing a final return, also see: Form 1041 – Final Year Deductions for information on entering these final year deductions. Once all of the questions in this Other Information Menu have been answered, you should exit to return to the Main Menu of the tax return (Form 1041).
Note: In the following Steps 7-16, you will enter the Income, Deductions and certain Distributive Items that will be passed through to the beneficiaries on their K-1s. You should skip any step in this section that is not applicable to the estate or trust and only complete those items that are necessary for the return.
Step 7 – Income – From the Main Menu of the tax return (Form 1041) select Income. Here you will enter the appropriate portfolio income (interest, dividends and capital gains) trade or business activity income (Schedule C or Schedule F) rental income (Schedule E), or other income items in this section. Many of the items entered in this section are similar to what an individual taxpayer would enter on a Form 1040 and the forms completed (Schedules C, E & F) are the same as what is filed with a Form 1040.
Typically, some portion of the income reported in this section may be subject to distribution to the beneficiaries if the estate or trust was required to distribute income currently or if it paid, credited, or was required to distribute any other amounts to beneficiaries during the tax year. Whether the income can be distributed is discussed further in Step 15 where the user completes Schedule B to determine the estate’s or trust’s income distribution deduction.
In this Income Menu certain income items may require additional attention which will be addressed in Step 8-10.
Step 8– Income Menu – Interest/Dividends – Report the estate’s or trust’s taxable interest and/or any ordinary and qualified Dividends that were received during the tax year. In addition, any non-taxable interest or dividends will be entered in this section, however these non-taxable interest/dividends are not carried to Form 1041. Instead, any non-taxable interest or dividends must be accounted for on the return by including the non-taxable interest/dividends in the Allocation of Deductions For Tax Exempt Income in Step 14. If the user enters any amount for non-taxable interest or dividends, they will be given an option when they exit the respective Interest or Dividend menu(s) allowing them to complete an Allocation of Deductions For Tax Exempt Income. Most users may want to do this allocation in Step 15 after they have entered most deductions for the entity and before they complete the Income Distribution Deduction.
When entering dividends on this menu, the user has the opportunity to allocate any qualified dividends between the entity and the beneficiaries. If the dividends are allocated to the entity it will be consider part of the taxable income of the entity. If the qualified dividends are allocated to the beneficiaries, the dividends apportioned will only be reported to the beneficiary on a Schedule K-1 (Form 1041) to the extent permitted based on the apportionment of deductions on the return.
Step 9 – Income Menu – Capital Gain (Loss) (Sch. D) – In this section the user will report the estate’s or trust’s capital gain or loss transactions. After completions of these capital gain or loss transactions and upon exiting the Schedule D Capital Gain/Loss Menu, the user will be taken to the Schedule D – Allocation Menu. It is at this menu that a user has the opportunity to allocate the Capital Gains between the Beneficiaries and the Estate or Trust. Net Capital Gains can be distributed to the beneficiary but unless the entity is filing a Final Return, the entity is not allowed to distribute a Net Capital Loss to the beneficiaries. If the user does not allocate any Capital Gains to the beneficiaries, it will be taxed on the Form 1041. Any Capital Gains allocated to the beneficiaries will only be reported on a beneficiary’s Schedule K-1 (Form 1041) to the extent permitted based on the apportionment of deductions on the return.
Step 10 – Income Menu – Rents, Royalties, Prtn., & Other Estates (Sch. E) – In this section the user will report the estate’s or trust’s transactions that will flow to the Schedule E. If the entity receives a K-1 from some other entity or has royalties, it will be reported in this section. If the entity has any rental activities, those rental activities will be entered on this menu. If the return is being filed for an estate and the decedent was considered an active participant in real estate activities prior to their death, the estate will be considered to be actively participating in the activity for the first two years of the estate’s existence and up to $25,000 of deductions and deduction equivalents of credits from rental real estate activities in which the decedent actively participated are allowed. Any excess losses or credits are suspended for the year and carried forward by the entity.
Once you have entered all the income items, exit the Income Menu and return to the Main Menu of the tax return, Form 1041.
Step 11 – Deductions Menu – From the Main Menu of the tax return, Form 1041, select Deductions. Here you will enter the appropriate deductions/expenses of the entity. The deductions reported in this section will reduce the taxable income that the entity will report on Form 1041 or the income that is available for distribution to the beneficiaries of the estate or trust. If the entity has any charitable deductions it will require additional attention which will be addressed in Step 12. Also, if the entity has any tax-exempt income reported on the return, the user should recognize that certain deductions may need to be reduced by the amount of the expense/deduction that is being allocated to the tax-exempt income as addressed in Steps 13-14.
Step 12 – Deductions Menu – Charitable Deductions – In this section the user will report any Charitable Gifts that have been made by the estate or trust. These deductions must be authorized by either the decedent’s will or by the trust document and must be paid out of income of the estate or trust and not from the corpus of the trust or assets of the estate. If Charitable Gifts have been made by the entity, you must complete Schedule A, which is part of Form 1041. If you need additional information regarding this deduction you should review the section on Schedule A in the Instructions for Form 1041 – US Income Tax Return for Estates and Trusts.
In order to properly allocate the charitable gift to the category of income that generated the charitable deduction, from the Deductions Menu, select Charitable Deductions. Any estate or trust that pays or sets aside any part of its income for a charitable purpose must reduce the deduction taken on the Form 1041 by the portion of the gift allocable to tax-exempt income. If the governing instrument (Will or trust document) specifically provides the source of income from which any charitable deduction is to be made, that specific provision will control. In all other cases, the user must determine the amount of tax-exempt income allocable to charitable contributions by multiplying the actual charitable contribution by a fraction which is the total tax-exempt income of the estate or trust divided by the gross income of the estate or trust (without considering any losses allocated to entity). This amount should then be entered on Schedule A as Tax-Exempt Income allocable to Charitable Deductions. For example, if 50% of the income from the estate or trust comes from tax-exempt sources, then 50% of the charitable deduction will be allocated to tax-exempt income and the deduction taken on the Form 1041 will be reduced by that amount on Schedule A, Form 1041.
Once you have entered the deduction items and before determining the Income Distribution Deduction and any Deduction for Estate Taxes, if the entity has any tax exempt income this is an appropriate time to complete the Allocation of Deductions for Tax Exempt Income. If the entity has no tax exempt income, you can skip Steps 13-14, and proceed to Step 15.
Step 13– Allocation of Deductions for Tax Exempt Income. The Internal Revenue Code provides that generally no deduction that would otherwise be allowable can be allowed for any expense that is allocable to tax-exempt income. For this reason, a return with tax-exempt income (such as interest, dividends) must make an allocation of any deductions on the return between the tax exempt income and taxable income. In Step 12, Charitable Deductions were allocated towards tax-exempt income on Schedule A. The user should next allocate any other deductions that were incurred by the entity. If an expense is directly associated with one type of income, then that expense may be apportioned to that type of income. For example, state income taxes paid on tax-exempt income at the federal level may be apportioned towards that category of income because they are directly associated with that tax-exempt income. while an expense associated only with a taxable income can be allocated towards that category of income. However, the user should make a reasonable proportion of expenses indirectly allocable to both tax-exempt income and taxable income and these indirect expenses should be allocated to each class of income.
Step 14– Other Information Menu – Tax Exempt Income Allocation Statement – From the Main Menu of the tax return, Form 1041, select Other Information, then select Tax Exempt Income Allocation Statement. At this allocation menu, each deduction item that is to be allocated between tax-exempt income and taxable income should be entered by selecting NEW. The user will be allowed to enter a Description of the Deduction, the portion of the Deduction that was allocated to taxable income (which should correspond to the amount(s) entered in Steps 11 -12) and the portion of the deduction that was allocated to tax-exempt income, if any, and an Explanation of the Apportionment. This information will then be included with the electronic file that is sent with the return as a Supplemental Statement and Note and can be reviewed from the View Results Menu accessed from the main menu of the tax return (Form 1041). Failure to include this Tax Exempt Income Allocation Statement when there is tax-exempt income on the tax return can cause the return to be rejected by the IRS when it is electronically filed. Once you have completed the Tax Exempt Income Allocation Statement, return to the Main Menu of the tax return, Form 1041.
Step 15 – Deductions Menu – Income Distribution Deduction – From the Main Menu of the tax return, Form 1041, select Deductions, then select Income Distribution Deduction (Sch. B). The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to Distributable Net Income (“DNI”). This DNI amount is calculated on Schedule B, Form 1041 and is used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be included on the beneficiary’s tax return. On this menu, Keystone Tax Solutions Pro pulls the income items and deductions previously entered in order to calculate DNI and it also pulls any amounts allocated to the beneficiaries from Capital Gains (Schedule D) and Qualified Dividends. On this menu, the user will need to enter the amount of the Distributable Net Income, if any, that was required to be distributed to the beneficiaries under the will or trust document and any amount that was actually paid, distributed or credited to the beneficiaries. If there was tax-exempt income on the return, the user may also need to make entries regarding this income item and whether it was distributed to the beneficiaries. For additional information on the Income Distribution Deduction, how it is calculated and input in Keystone Tax Solutions Pro see: Form 1041 – Income Distribution Deduction.Once you have completed the Income Distribution Deduction, return to the Deductions Menu.
Step 16 – Unless the entity needs to enter on this Deductions Menu an Estate Tax Deduction or Generation Skipping Tax Deduction (both of which are not common), the user can return to the Main Menu of the tax return (Form 1041). Having completed the above steps, Keystone Tax Solutions Pro has applied the exemption amount for the type of entity and calculated the Taxable Income on the tax return. The current exemption amount on a Form 1041 is $600 for a Decedents’ Estate, $300 for a trust that is required to distribute all income currently, and $100 for all other trusts other than a Qualified Disability Trust which (subject to income limitations) is allowed the same amount as one personal exemption on a Form 1040. At this point, the user should from the Main Menu of the tax return, Form 1041, select Tax and Payments.
Step 17– Tax and Payments –Total Tax (Sch. G) – In this section the user will determine the tax liability for the entity by selecting Total Tax (Sch. G). It is at this menu where the user can assess different menus such General Business Credits (Form 3800), Foreign Tax Credits (Form 1116) and other available credits. It is also in this section where other tax calculation menus are assessed such as the Tax on Lump Sum Distributions (Form 4972), Alternative Minimum Tax (Sch. I), Net Investment Tax (Form 8960) and Household Employment Taxes (Sch. H). Once you have entered all credits and other taxes, exit the menu and return to the Tax and Payment Menu.
Step 18 – Tax and Payments –Total Payments – In this section the user will enter any payments from Estimates or with an Extension and any withholding that have been credited to the entity. It is also on this menu that the user can report any estimated payments made on behalf of a beneficiary on Form 1041-T. For additional information See: Form 1041-T-Allocation of Estimated Tax Payments to Beneficiaries. Once you have entered all payments and withholdings, exit the menu and return to the Main Menu of the tax return (Form 1041). If you have to distribute items to the beneficiaries, proceed to Step 19 – Schedule K-1. If you do not have anything to distribute to any beneficiary, proceed to Step 23 – Mark Return Electronic.
Step 19 – Schedule K-1 – From the Main Menu of the tax return, Form 1041, select Schedule K-1 Menu. If upon entering this menu you are given a warning the “Distributable Net Income does not equal Income Required to be Distributed Currently), you may have not correctly calculated DNI or made some adjustment to the return. If you receive this warning you can select Edit Income Distribution Deduction and Keystone Tax Solutions Pro will indicate the possible issue and automatically correct the DNI amount if the user selects to do so. It is also on this menu that a user (1) can select the setting for Automatically Distribute Schedule K Information (Step 20); (2) review and/or edit the Beneficiary Income Allocation Information (Step 21) (3) create the Schedule K-1 (From 1041) – Beneficiary Share of Income, Deductions, Credits, etc. for each beneficiary of the estate or trust (Step 22).
Step 20 – Schedule K-1 – From the Schedule K-1 Menu, answer the question Automatically Distribute Schedule K Information? Normally this question should be answered YES and Keystone Tax Solutions Pro will automatically distribute all income items to the individual beneficiaries K-1s based on the Beneficiary Income Allocation Percentage that is established for each beneficiary. If this question is answered NO, the user will have to make all entries on the individual K-1s manually and Keystone Tax Solutions Pro will not distribute the items to the individual K-1s. Typically, this question is only answered NO if different types of income items are allocated to the beneficiaries in different percentages.
Step 21 – Schedule K-1 – From the Schedule K-1 Menu, select Distribution Information – On this menu, the user can review the allocation of income items that are being distributed to the beneficiaries after consideration of any deductions taken on the Form 1041. Because all non-direct deductions must be allocated across the different classifications of income proportionately, this is the menu where a user can make limited adjustments to those allocations.
Step 22 – Schedule K-1 – From the Schedule K-1 Menu select Schedule K-1 Input and then select New. You will be asked if the beneficiary is an Individual and be given the choice of YES or NO. If you answer Yes the entry screen will be designed for an individual and require Name, Address Social Security Number and Beneficiary Income Allocation Percentage. If the beneficiary is not an Individual, you will be required to provide similar information except you will need the Employer Identification Number (EIN for the beneficiary/entity. If Keystone Tax Solutions Pro is automatically distributing the Schedule K-1 information, the K-1s should be complete. If the user chose to manually enter the distributed items, this can be done by selecting Allocate Share Items on each beneficiary’s K-1 Menu. Step 22 will be repeated for each beneficiary until 100% of the Beneficiary Income Allocation Percentage has been allocated and all distributive items have been accounted for on the K-1s.
Step 23 – Mark Return Electronic – When all entries have been completed on the tax return, from the Main Menu of the tax return (Form 1041), select Mark Return Electronic if you want to e-file the return. If you have failed to enter certain required information the program will prompt you to correct the items before proceeding. Once you have successfully marked the return for e-file, you will be able to transmit the return from the Electronic Filing Menu which is accessed from the Business Main Menu after exiting the return. To exit the return press enter or select the Exit button.
Step 24 – Receipt Menu – Select Exit from the Main Menu of the tax return (Form 1041). The Receipt Menu displays an overview of the calculated fees. You have the option to view and edit the invoice or enter a payment. When you exit the Receipt Menu you will be asked “Are You Ready to Mark the Return Complete?” Answer NO if the return is not complete. Answer YES to mark the return complete and exit back to the Keystone Tax Solutions Pro Business menu.
NOTE: This is a guide on entering Form 1041- U.S. Income Tax Return for Estates and Trusts into the Keystone Tax Solutions Pro program. This is not intended as tax advice.
Additional Information:
Instructions for Form 1041 – US Income Tax Return for Estates and Trusts
Instructions for Schedule K-1 (Form 1041) for a Beneficiary Filing Form 1040
Creating a Basic Form 1065 – US Return of Partnership Income
Creating a Basic Form 1120S – U.S. Income Tax Return for an S Corporation
Creating a Basic Form 1120 – U.S. Corporate Income Tax Return