Income Tax Reporting Methods for Grantor Trusts
Determining the annual filing burden
This is the second part of a series on grantor trust tax reporting for federal income tax purposes. In Part 1, I discussed whether or not a grantor trust must obtain an EIN, or whether it can instead use the SSN of a grantor. In either case, just to recap, we needed a situation where one “grantor” was the deemed owner of all trust income and principal under the grantor trust rules. Alternatively, where we had two “grantors” who were joint filers, usually in the case of a married couple, we could choose one spouse’s SSN so long as both spouses were living and filing jointly.
(And, if you are curious about how to determine this grantor trust status, I am working on a broader course on the subject. It should come out in 2024.)
But, as you recall, we couldn’t just stop with the one-grantor requirement. The need for a separate trust EIN was also based on the method of reporting selected by the trustee. As a default, Treas. Reg. 1.671-4(a) generally requires that a grantor trust file a 1041 each year, but instead of filling out the info on income, deductions and credits on the form itself, this info is instead included on a self-authored statement (somewhat like a K-1 without an IRS form) to be provided to the grantor(s). If this default method is used, an EIN is required under Treas. Reg. 301.6109-1(a)(2).
However, Treas. Reg. 1.671-4(b) sets forth optional reporting methods that may be elected by the trustee for a trust which is a wholly-grantor trust (i.e., all trust income and principal is deemed to be owned by one or more people in the aggregate). As we saw in the first article, so long as the optional reporting method described in Treas. Reg. 1.671-4(b)(2) (what we will come to know below as “Optional Method 1”) is used, the need for a trust EIN may be waived in the case of a single grantor or deemed owner. And, as we will discuss in this article, use of these optional reporting methods where available may also relieve the trust of the need to file a 1041.
Use of Optional Methods
Much of the guidance on optional methods can be found in the Instructions for Form 1041. In the 2022 edition upon which this article is based, you can find this guidance under “Special Reporting Instructions.”
Before jumping in, however, it is important to note that the Treasury Regulations and these instructions generally do not distinguish between an irrevocable grantor trust, and a revocable grantor trust. The instructions do note, however, that most grantors of revocable trusts will select Optional Method 1 in reporting trust income as it is perhaps the least burdensome. As we see on Page 5 of the 2022 Instructions:
Be sure to read Optional Filing Methods for Certain Grantor Type Trusts, later. Generally, most people that have revocable living trusts will be able to use Optional Method 1. This method is the easiest and least burdensome way to meet your obligations.
Which brings us to Optional Methods 1, 2, and 3. These were largely covered in the first article, but as you recall they involve the trustee’s choice (coupled with the determination of whether the grantor themselves is a trustee). To recap:
Optional Method 1 involves the trustee giving each payor of income to the trust the grantor’s SSN and the address of the trust itself, coupled with a statement of all items of income, deduction, and credit from the trustee to the grantor (if the grantor is not a trustee or co-trustee). To use this method, the grantor must provide the trustee with a W-9 (even if the grantor themselves is trustee).
Optional Method 2 involves the trustee giving each payor of income to the trust the trust EIN and the address of the trust itself, but with the added step of the trustee issuing a 1099 for each type of income paid to the trust from a payor. Each 1099 is due by February 28/29 of the following year if filed manually, or March 31 if filed electronically. Again, if the grantor is not a trustee, the trustee must also provide the statement to the grantor described in Optional Method 1 (which eliminates the need for the trust to issue 1099s from the trust to the grantor).
Optional Method 3 is only used when there are two or more grantors or deemed owners who, in the aggregate, are treated as owning all trust income and principal under the grantor trust rules. The procedure is the same as for Optional Method 2, but with the statements to grantors being required even if a grantor is a trustee. Each such statement must report each grantor’s respective shares of items of income, deduction and credit.
To recap our general requirements, only Optional Method 1 waives the requirement for a trust EIN. But, all Optional Methods waive the requirement for a 1041.
Note that certain trusts cannot use the Optional Methods, and thus must use the 1041 procedure below. These trusts include, but are not limited to, a QSST or a trust for which a grantor or deemed owner is not a U.S. person.
The 1041 Filing Requirement
If the trustee does not elect to use Optional Methods 1, 2, or 3, then a 1041 is required. But, as noted above, the completion of the form may be abbreviated. As illustrated below, all that is needed for a portion of a trust which is treated as a grantor trust is the basic trust info, along with the selection of “Grantor-Type Trust” and the issuance of a statement of all items of income, deduction, and credit to each grantor who is a deemed owner of such items:
Note that if a trust is a partial-grantor trust, you must check both the Grantor-Type Trust box, and the appropriate box for the non-grantor portion (usually a Complex Trust, but sometimes a Simple Trust). Then, the income, deductions and credits of the non-grantor portion must be reported on the rest of the form.
For a QSST, it will be a wholly-grantor trust with respect to the primary income beneficiary. In such a case, you would still use the abbreviated 1041 filing procedure above (except for a sale or disposition of QSST stock, which is usually taxable to the trust unless some other grantor trust exception applies to this sale portion). In a future article and/or course, I will cover more reporting nuances for a QSST and ESBT.
Importantly, as you will see above, this method requires an EIN for the trust - you cannot use the grantor’s or deemed owner’s SSN.
Conclusion
These rules are often overlooked, especially for revocable trusts. It is important in the case of a revocable trust or irrevocable grantor trust to at least have a W-9 on file for the trust, but also to note that Optional Method 1 requires use of the trust’s (and not the grantor’s) address.
In my next installment, I will cover what to do when a grantor dies - especially in the case of a 645 election. We will also discuss whether a division of a trust into separate sub-trusts necessitates a new EIN for each sub-trust share.
