There are occasions when a client prefers to use their CPA to file Trust tax returns rather than the Trustee. In these instances, the Trustee should ensure the CPA filing the tax returns is filing the returns correctly. The Trustee can do this by reviewing the Trust Agreement to ensure the tax return that is being filed is appropriate and review the return to ensure it been filed correctly. We have had two scenarios in 2018 where outside tax preparers filed incorrect Tax returns, as listed below;
Irrevocable Grantor Trust
When a Trust is considered a Grantor Trust for tax purposes the Grantor is responsible for the Trust tax liability. The Grantor will receive a Grantor Tax Letter annually that reports all taxable items from the Trust for that year. This information would need to be included in the Grantor’s personal income tax return.
- In late 2018, FSTC was appointed Trustee of a new Trust. We were advised that an outside tax preparer was to be used. This Trust has a 30% ownership in an interest in an LLC. The LLC owned a company that was sold in December of 2018. The tax liability for the sale of the company would ultimately pass to the Trust based on its ownership of the company. The tax liability would be reported on a K-1 issued from the LLC.
- The outside tax preparer forwarded to the Trust Officer a tax estimate payment that was to be paid from the Trust to cover the estimated income due for the sale of the company.
- Upon reviewing the agreement, the Trust Officer noticed that the Grantor had the ability to substitute assets of equivalent from the Trust and his personal assets. This power given to the Grantor would cause inclusion of all the Trust’s tax liability within the Grantor’s personal income tax liability.
- The Trust Officer contacted the Grantor and advised that his CPA should be forwarding him a K-1 annually which report the Trust’s annual tax liability, as the Trust is a Grantor Trust for tax purposes. The Grantor advised that he did not intend to be responsible for the Trust tax liability as there would be a significant tax liability to the Trust for the sale of the company in the LLC.
- The Grantor contacted his attorney and rescinded his power to be substitute assets from the Trust effective to a date prior to the sale of the company in the LLC.
- In most cases, the client’s attorney and CPA would be on the same page regarding how the Trust tax returns are to be filed. The Grantor did want to be liable for the Trust tax liability and should have been advised by his attorney how the Trust was structured, so this issue could have been avoided. All parties involved should have discussed how the Trust tax returns should be filed prior to a return being filed, if an outside tax preparer is to be used.
Irrevocable Non-Grantor Trust
- FSTC had accepted a Trust in late 2016. We were notified that an outside tax preparer was to be used for the filing of the Trust 2017 tax return.
- The outside tax preparer filed an extension for the Trust in March of 2018. In September, the tax preparer forwarded to the Trust Officer the final tax return for 2017.
- The Trust Officer noticed that a distribution deduction has been taken on the return. The income tax liability for the Trust was reflected on the beneficiary’s K-1 in the amount of the distribution deduction reflected on the return.
- Upon reviewing the transactions of the Trust for 2017, the Trust Officer noticed that there had been no distributions made from the Trust in 2017. An income distribution deduction should not have been taken, and there was no reportable income for the beneficiary. A K-1 for the beneficiary should have been generated.
- The Trust Officer advised the CPA of the error, and corrections were made to the Trust tax return. The Trust tax liability was paid from the Trust.
It’s the Trustee’s responsibility to ensure the Trust tax returns are being filed correctly, whether if it’s an outside tax preparer or the Trustee’s tax preparer. These are two examples of issues that we have dealt with when outside tax preparers have been used to file Trust tax returns. There are potentially many more issues that could arise. It’s important for the Trustee to review the Trust Agreement and ensure the Tax returns are completed correctly prior to any tax filings.
Keith Al-Chokhachy, CTFA, CFP®