Trust Distribution Basics
When a trust distributes funds to a beneficiary, the distribution is categorized as either income or return of principal. Under IRS rules, principal distributions are not taxable, as it’s assumed that this money has already been taxed once before it was placed into the trust. However, any income or interest the money earns after it’s inside the trust is considered taxable income.
If the trust holds the income and does not distribute it before the end of the year, the trust is responsible for paying the taxes. However, if the income has been distributed, it is taxable to the beneficiary who receives it. Distributions are assumed to be made up of current-year income first, then any remaining amount is attributed to the principal balance.
Reporting Taxable Trust Distributions
When a trust distributes income to one or more beneficiaries, the trust takes a deduction using Form 1041. It then issues a K-1 Trust Distribution Form to each beneficiary. This form shows the amount that was distributed and how much was attributed to income versus principal. The K1 Form also reports any deductions or credits. With this information, a trust beneficiary will be able to figure out their tax liability for the year.
Individuals who receive a K-1 Trust Distribution Form must include the amounts reported on their personal income tax return. Failing to do so will typically result in penalties, which can sometimes be quite steep. If you’re working with a tax professional, it’s important to provide a copy of this form to ensure your taxes are filed correctly.
Other Types of K-1 Forms
While we’ve just covered the basics of a K-1 Trust Distribution Form, it’s important to note that there are other types of K-1 Forms. Schedule K-1 Form 1065 and Schedule K-1 Form 1120S are used to report income earned by other types of “pass-through entities.” These organizations shift tax liability from the entity itself to the individuals who hold an interest in them.
You’re likely to receive these types of K-1 forms if you are an S-corporation shareholder, business partner, limited partnership investor, and/or an investor in certain exchange-traded funds (ETFs).
The Bottom Line
If you’re the beneficiary of a trust or estate or are involved with any of the entity types mentioned above, you should be on the lookout for a K-1 each year. If you receive this form, either you or your tax preparer will need to include the information on your individual income tax return.
Generally, you should expect to receive your K-1 Forms on or around March 15th. Unless the form includes backup withholding in box 13 (code B), you won’t need to file it with your tax return. However, you’ll want to keep all K-1 Forms for your records.
Even if you’ve filed your own taxes for years, receiving a K-1 form can complicate matters. Before attempting to report this income on your tax return, it’s a good idea to consult with a tax professional. The experts at Gurian CPA are here to help. Reach out to us today to schedule a consultation.
