Trusts and Estates (2025)

Estate & Trust Creation

• Estate created automatically at taxpayer's death
• All estates and trusts (except revocable grantor trusts) must obtain EIN
• Returns called "fiduciary" returns
• Terminates when all assets/income distributed and all liabilities paid
• IRS can terminate if existence unnecessarily prolonged
• Loss in final year can pass through to beneficiaries (not in non-termination years)

Net Investment Income Tax (NIIT)

Rate & Filing

• 3.8% on net investment income
• Filed on Form 8960
• For estates/trusts: tax on lesser of (1) undistributed net investment income, OR (2) AGI exceeding threshold

2025 Threshold

• Estates/trusts: $15,650 (amount where highest tax bracket begins)

Taxable Net Investment Income

Taxable interest, dividends, capital gains from asset sales, rental/royalty income, non-qualified annuities, business income from financial instruments/commodities trading, passive activity income.

Exemptions

Does NOT apply to: tax-exempt trusts, grantor trusts, foreign estates/trusts (but may apply to their US beneficiaries).

Estate Overview & Federal Estate Tax

Key 2025 Amounts

Gross Estate

Includes ALL property owned at death (US citizen = worldwide assets):

• All real and personal property at FMV (date of death)
• Joint tenancy with spouse: 50% of value
• Joint tenancy with non-spouse: deceased's share (based on contribution to purchase price)
• Life insurance proceeds payable to estate/heirs
• Annuities/survivor benefits to heirs
• Certain property transferred within 3 years of death

Excluded from Gross Estate

• Property owned solely by surviving spouse or others
• Completed lifetime gifts (no retained control)
• Property in irrevocable trust (if grantor relinquished control)

Estate Tax Deductions

• Funeral expenses
• Estate administration expenses (if not deducted on Form 1041)
• Debts owed at death
• Marital deduction: unlimited — property passing to US citizen spouse
• Charitable deduction: property passing to qualified charity
• State death taxes

NOT Deductible from Gross Estate

• Federal estate taxes paid
• Post-death alimony payments

Form 706 — Estate Tax Return

• Required if gross estate >$13,990,000 (2025, assuming no lifetime taxable gifts)
• Due: 9 months after date of death
• Extension: Form 4768, 6 months
• Assessment period: 3 years from filing deadline (4 years for estate transfers)

Deceased Spouse Unused Exclusion (DSUE)

• Surviving spouse can use deceased spouse's unused exclusion amount
• Must elect by timely filing Form 706 for deceased spouse (even if not otherwise required)
• Only applies to most recently deceased spouse (remarriage can affect)
• Potential combined exclusion: up to $27,980,000 (2025)

Form 8971

• Executor must provide beneficiaries with statement of property values reported on estate tax return
• Schedule A provided to beneficiaries within 30 days of filing or filing deadline (whichever earlier)
• Prevents inconsistent basis reporting by beneficiaries

Probate & Executor/Administrator

Probate

Court-supervised estate administration. Not all estates require probate (state law governs).

Executor vs. Administrator

• Executor: Named in will (testate)
• Administrator: Court-appointed (intestate, no will)

Executor Duties

1. File Form 56 (Notice Concerning Fiduciary Relationship) — ASAP after EIN obtained
2. File decedent's final Form 1040
3. File estate Form 1041 (if required)
4. File Form 706 (if required)
5. Pay debts and taxes before distributing to beneficiaries
6. Form 1310: Required for refund claim if filed by someone other than surviving spouse

Executor Fees

Decedent's Final Income Tax Return (Form 1040)

• Filed same as living taxpayer — due April 15 of year following death
• Reports all income from Jan 1 through date of death
• If died before filing prior year return → executor must file both
• If died after tax year ended but before filing → that year's return is regular (not "final") return
• All deductions and credits available regardless of how long taxpayer lived during year
• Signing: executor signs as "Personal Representative"

Income in Respect of a Decedent (IRD)

Definition

Income earned by decedent before death but not yet received. NOT taxed on final Form 1040. Taxed to recipient (estate or beneficiary).

Sources

• Unpaid wages at death
• Traditional IRA and employer retirement plan distributions
• Deferred compensation
• Accrued but unpaid interest, dividends, rent
• Decedent sole proprietor's receivables

Character Retention

IRD retains same tax character as if decedent were alive (e.g., short-term capital gain → short-term capital gain to beneficiary).

Estate Tax Deduction for IRD

If IRD is included in gross estate AND estate tax paid on it:

• Beneficiary receiving IRD can deduct estate tax attributable to IRD
• Reported on Schedule A as itemized deduction (NOT subject to 2% AGI floor)
• Available even under current law (miscellaneous itemized deductions suspended)

Form 1041 — Estate/Trust Income Tax Return

Filing Requirement

Domestic estate must file if:

• Gross income ≥$600, OR
• Has nonresident alien beneficiary (regardless of income)

Trust must file if:

• Any taxable income, OR
• Gross income ≥$600, OR
• Nonresident alien beneficiary

Due Date

• 15th day of 4th month after year-end (April 15 for calendar year)
• Extension: Form 7004, 5.5 months (NOT 6 months like most other returns)
• Estate can elect fiscal year (commonly anniversary of death); trusts generally must use calendar year

Estate Administration

• Estate continues as taxable entity until all assets distributed
• Most estates settle within 18 months, but probate disputes can extend for years
• Administration expenses: can deduct on Form 1041 (income tax) OR Form 706 (estate tax) — not both
• Schedule K-1 (Form 1041) reports income distributed to beneficiaries

Distributable Net Income (DNI)

Definition

DNI = current income available for distribution; maximum amount taxable to beneficiaries. Prevents double taxation (income taxed either to entity OR beneficiary, not both).

Income Distribution Deduction (IDD)

• Calculated on Schedule B (Form 1041)
• Lesser of: (1) distributions − tax-exempt income, OR (2) DNI − tax-exempt income
• If estate/trust accumulates income (not distributed) → taxed at entity level

Example

Trust income: $25K taxable interest + $35K capital gains + $10K tax-exempt interest = $70K total. Trustee fees $5K. DNI = $65K ($70K − $5K). Distributions = $45K. IDD = lesser of $45K or $65K, minus $5K exempt = $40K. Each beneficiary gets K-1 showing their share.

Trust Types

Simple Trust

• Must distribute ALL income currently
• Cannot distribute corpus (principal)
• Cannot make charitable contributions
• Exemption: $300 (2025)

Complex Trust

• Can accumulate income
• Can distribute corpus
• Can make charitable contributions
• Any trust that is NOT a simple trust
• Exemption: $100 (2025)
• Can convert: simple trust failing to distribute all income → becomes complex trust that year

Grantor Trust

• Grantor retains control; treated as owned by grantor for tax purposes
• All income/deductions reported on grantor's personal Form 1040
• No separate trust income tax return required (generally)
• Avoids probate; maintains privacy
• Assets included in grantor's taxable estate at death
• Revocable living trust = grantor trust during life; becomes irrevocable at death

Non-Grantor Trust

• Separate taxable entity; grantor relinquished control
• Must file Form 1041
• Distributions to beneficiaries = taxable income to beneficiaries
• Types:
  • Irrevocable trust: Cannot be revoked; completed gift; NOT in grantor's estate; NO step-up in basis at death
  • Qualified Disability Trust (QDT): For disabled individuals; $5,100 exemption (2025); treated as complex trust
  • Charitable trust: Irrevocable; exempt from NIIT; donor gets charitable deduction

Trust Tax Rates

• Compressed tax brackets (reach top 37% at relatively low income)
• Simple trust: $300 exemption
• Complex trust: $100 exemption
• QDT: $5,100 exemption (2025)

§645 Election

Qualified revocable trust can elect to be treated as part of estate for first 2 years after death — simplifies filing (one Form 1041 instead of two).

Estate Property Basis

General Rule (Step-Up)

Inherited property basis = FMV at date of death (or alternative valuation date if elected). Inherited capital assets treated as long-term regardless of actual holding period.

Alternative Valuation Date

6 months after death (unless distributed earlier → FMV at distribution date). Must elect on Form 706; applies to ALL estate assets.

Special Use Valuation

For agricultural or closely-held business real property — can use special use value instead of FMV.

Jointly Owned Property

Abusive Trust Arrangements

Warning Signs

• Trust pays personal expenses (claiming deductions)
• Depreciation on personal residence/furniture
• Step-up basis on transferred property
• Elimination/reduction of SE tax
• Reduction/elimination of gift/estate tax

Rule

Trusts cannot convert personal expenses to tax deductions. Someone must pay tax on trust income. If not, likely abusive trust arrangement. Civil and criminal penalties possible.

Legitimate vs. Abusive

• Legitimate: QDT for disabled family member, charitable trust for estate planning — income IS taxed (usually to beneficiary)
• Abusive: Multiple trusts holding personal assets, claiming personal expenses as deductions, hiding income ownership

Foreign Trusts

Definition

Trust is "foreign" unless: (1) US court can exercise primary supervision, AND (2) US persons control all substantial decisions.

IRS Monitoring

Closely monitored due to abuse potential (tax haven jurisdictions). Legitimate uses exist, but additional reporting required.

Reporting Forms

Key 2025 Trust/Estate Amounts

Key Connected Rules

• Tax-Exempt Organizations → See tax-exempt-organizations.md
• Agricultural Enterprises → See agricultural-enterprises.md
• Business Entities Overview → See business-entities-overview.md