Changes To Note

• For tax years beginning in 2002, the requirement to file a return for a bankruptcy estate applies only if gross income is at least $6,925.
• For tax years beginning in 2003, the estimated tax safe harbor that is based on the tax shown on the prior year tax return is increased to 110% of that amount if the adjusted gross income on that return is more than $150,000 and less than 2/3 of gross income for 2002 or 2003 is from farming or fishing.
• For 2002, qualified disability trusts can claim an exemption of up to $3,000. See the instructions for line 20 on page 17 for more details.
• The estate or trust must file a disclosure statement for each reportable tax shelter transaction in which it participated, directly or indirectly, if the transaction is reasonably expected to affect the estate's, trust's, or beneficiary's Federal income tax liability. See page 9 for more information.

Photographs of Missing Children

The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children selected by the Center may appear in instructions on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.

Unresolved Tax Issues

If you have attempted to deal with an IRS problem unsuccessfully, you should contact the Taxpayer Advocate. The Taxpayer Advocate independently represents the estate's or trust's interests and concerns within the IRS by protecting its rights and resolving problems that have not been fixed through normal channels.

While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that the estate's or trust's case is given a complete and impartial review.

The estate's or trust's assigned personal advocate will listen to its point of view and will work with the estate or trust to address its concerns. The estate or trust can expect the advocate to provide:

• A fresh look at a new or on-going problem.
• Timely acknowledgment.
• The name and phone number of the individual assigned to its case.
• Updates on progress.
• Timeframes for action.
• Speedy resolution.
• Courteous service.

When contacting the Taxpayer Advocate, you should provide the following information:

• The estate's or trust's name, address, and employer identification number.
• The name and telephone number of an authorized contact person and the hours he or she can be reached.
• The type of tax return and year(s) involved.
• A detailed description of the problem.
• Previous attempts to solve the problem and the office that had been contacted.
• A description of the hardship the estate or trust is facing (if applicable).

The estate or trust may contact a Taxpayer Advocate by calling 1-877-777-4778 (toll free). Persons who have access to TTY/TDD equipment may call 1-800-829-4059 and ask for Taxpayer Advocate assistance. If the estate or trust prefers, it may call, write, or fax the Taxpayer Advocate office in its area. See Pub. 1546, The Taxpayer Advocate Service of the IRS, for a list of addresses and fax numbers.

How To Get Forms and Publications

Personal Computer

You can access the IRS web site 24 hours a day, 7 days a week at www.irs.gov to:

• Download forms, instructions, and publications.
• Order IRS products on-line.
• See answers to frequently asked tax questions.
• Search publications on-line by topic or keyword.
• Send us comments or request help by e-mail.
• Sign up to receive local and national tax news by e-mail.

You can also reach us using file transfer protocol at ftp.irs.gov.

CD-ROM

Order Pub. 1796, Federal Tax Products on CD-ROM, and get:

• Current year forms, instructions, and publications.
• Prior year forms, instructions, and publications.
• Frequently requested tax forms that may be filled in electronically, printed out for submission, and saved for recordkeeping.
• The Internal Revenue Bulletin.

Buy the CD-ROM on the Internet at www.irs.gov/cdorders from the National Technical Information Service (NTIS) for $22 (no handling fee) or call 1-877-CDFORMS (1-877-233-6767) toll free to buy the CD-ROM for $22 (plus a $5 handling fee).

By Phone and in Person

You can order forms and publications 24 hours a day, 7 days a week, by calling 1-800-TAX-FORM (1-800-829-3676). You can also get most forms and publications at your local IRS office.

General Instructions

Purpose of Form

The fiduciary of a domestic decedent's estate, trust, or bankruptcy estate uses Form 1041 to report:

• The income, deductions, gains, losses, etc. of the estate or trust;
• The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries;
• Any income tax liability of the estate or trust; and
• Employment taxes on wages paid to household employees.

Income Taxation of Trusts and Decedents' Estates

A trust (except a grantor type trust) or a decedent's estate is a separate legal entity for Federal tax purposes. A decedent's estate comes into existence at the time of death of an individual. A trust may be created during an individual's life (inter vivos ) or at the time of his or her death under a will (testamentary ). If the trust instrument contains certain provisions, then the person creating the trust (the grantor ) is treated as the owner of the trust's assets. Such a trust is a grantor type trust. See page 4 for special rules for grantor trusts.

A trust or decedent's estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, there is one major distinction. A trust or decedent's estate is allowed an income distribution deduction for distributions to beneficiaries. To figure this deduction, the fiduciary must complete Schedule B. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries.

For this reason, a trust or decedent's estate sometimes is referred to as a pass-through entity. The beneficiary, and not the trust or decedent's estate, pays income tax on his or her distributive share of income. Schedule K-1 (Form 1041) is used to notify the beneficiaries of the amounts to be included on their income tax returns.

Before preparing Form 1041, the fiduciary must figure the accounting income of the estate or trust under the will or trust instrument and applicable local law to determine the amount, if any, of income that is required to be distributed, because the income distribution deduction is based, in part, on that amount.

Abusive Trust Arrangements

Certain trust arrangements purport to reduce or eliminate Federal taxes in ways that are not permitted under the law. Abusive trust arrangements typically are promoted by the promise of tax benefits with no meaningful change in the taxpayer's control over or benefit from the taxpayer's income or assets. The promised benefits may include reduction or elimination of income subject to tax; deductions for personal expenses paid by the trust; depreciation deductions of an owner's personal residence and furnishings; a stepped-up basis for property transferred to the trust; the reduction or elimination of self-employment taxes; and the reduction or elimination of gift and estate taxes. These promised benefits are inconsistent with the tax rules applicable to trust arrangements.

Abusive trust arrangements often use trusts to hide the true ownership of assets and income or to disguise the substance of transactions. These arrangements frequently involve more than one trust, each holding different assets of the taxpayer (e.g., the taxpayer's business, business equipment, home, automobile, etc.). Some trusts may hold interests in other trusts, purport to involve charities, or are foreign trusts. Funds may flow from one trust to another trust by way of rental agreements, fees for services, purchase agreements, and distributions.

Some of the abusive trust arrangements that have been identified include unincorporated business trusts (or organizations), equipment or service trusts, family residence trusts, charitable trusts, and final trusts. In each of these trusts, the original owner of the assets that are nominally subject to the trust effectively retains the authority to cause financial benefits of the trust to be directly or indirectly returned or made available to the owner. For example, the trustee may be the promoter, or a relative or friend of the owner who simply carries out the directions of the owner whether or not permitted by the terms of the trust.

When trusts are used for legitimate business, family, or estate planning purposes, either the trust, the beneficiary, or the transferor to the trust will pay the tax on income generated by the trust property. Trusts cannot be used to transform a taxpayer's personal, living, or educational expenses into deductible items, and will not seek to avoid tax liability by ignoring either the true ownership of income and assets or the true substance of transactions. Therefore, the tax results promised by the promoters of abusive trust arrangements are not allowable under the law, and the participants in and promoters of these arrangements may be subject to civil or criminal penalties in appropriate cases.

For more details, including the legal principles that control the proper tax treatment of these abusive trust arrangements, see Notice 97-24, 1997-1 C.B. 409.

Definitions

Beneficiary

A beneficiary includes an heir, a legatee, or a devisee.

Distributable Net Income (DNI)

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 amount, which is figured on Schedule B, line 7, is also used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be includible in his or her gross income.

Income, Deductions, and Credits in Respect of a Decedent

Income.   When completing Form 1041, you must take into account any items that are income in respect of a decedent (IRD).

In general, income in respect of a decedent is income that a decedent was entitled to receive but that was not properly includible in the decedent's final income tax return under the decedent's method of accounting.

IRD includes:

• All accrued income of a decedent who reported his or her income on the cash method of accounting;
• Income accrued solely because of the decedent's death in the case of a decedent who reported his or her income on the accrual method of accounting; and
• Income to which the decedent had a contingent claim at the time of his or her death.

Some examples of IRD of a decedent who kept his or her books on the cash method are:

• Deferred salary payments that are payable to the decedent's estate.
• Uncollected interest on U.S. savings bonds.
• Proceeds from the completed sale of farm produce.
• The portion of a lump-sum distribution to the beneficiary of a decedent's IRA that equals the balance in the IRA at the time of the owner's death. This includes unrealized appreciation and income accrued to that date, less the aggregate amount of the owner's nondeductible contributions to the IRA. Such amounts are included in the beneficiary's gross income in the tax year that the distribution is received.

The IRD has the same character it would have had if the decedent lived and received such amount.

Deductions and credits.   The following deductions and credits, when paid by the decedent's estate, are allowed on Form 1041 even though they were not allowable on the decedent's final income tax return:

• Business expenses deductible under section 162.
• Interest deductible under section 163.
• Taxes deductible under section 164.
• Investment expenses described in section 212 (in excess of 2% of AGI).
• Percentage depletion allowed under section 611.
• Foreign tax credit.

For more information, see section 691 or Income in Respect of a Decedent in Pub. 559, Survivors, Executors, and Administrators.

Income Required To Be Distributed Currently

Income required to be distributed currently is income that is required under the terms of the governing instrument and applicable local law to be distributed in the year it is received. The fiduciary must be under a duty to distribute the income currently, even if the actual distribution is not made until after the close of the trust's tax year. See Regulations section 1.651(a)-2.

Fiduciary

A fiduciary is a trustee of a trust; or an executor, executrix, administrator, administratrix, personal representative, or person in possession of property of a decedent's estate.

Note:   Any reference in these instructions to you means the fiduciary of the estate or trust.

Trust

A trust is an arrangement created either by a will or by an inter vivos declaration by which trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.

Who Must File

Decedent's Estate

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic estate that has:

1. Gross income for the tax year of $600 or more or
2. A beneficiary who is a nonresident alien.

An estate is a domestic estate if it is not a foreign estate. A foreign estate is one the income of which, from sources outside the United States that is not effectively connected with the conduct of a U.S. trade or business, is not includible in gross income. If you are the fiduciary of a foreign estate, file Form 1040NR, U.S. Nonresident Alien Income Tax Return, instead of Form 1041.

Trust

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has:

1. Any taxable income for the tax year,
2. Gross income of $600 or more (regardless of taxable income), or
3. A beneficiary who is a nonresident alien.

Two or more trusts are treated as one trust if such trusts have substantially the same grantor(s) and substantially the same primary beneficiary(ies) and a principal purpose of such trusts is avoidance of tax. This provision applies only to that portion of the trust that is attributable to contributions to corpus made after March 1, 1984.

A trust is a domestic trust if:

• A U.S. court is able to exercise primary supervision over the administration of the trust (court test) and
• One or more U.S. persons have the authority to control all substantial decisions of the trust (control test).

See Regulations section 301.7701-7 for more information on the court and control tests.

Also treated as a domestic trust is a trust (other than a trust treated as wholly owned by the grantor) that:

• Was in existence on August 20, 1996,
• Was treated as a domestic trust on August 19, 1996, and
• Elected to continue to be treated as a domestic trust.

A trust that is not a domestic trust is treated as a foreign trust. If you are the trustee of a foreign trust, file Form 1040NR instead of Form 1041. Also, a foreign trust with a U.S. owner generally must file Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner.

If a domestic trust becomes a foreign trust, it is treated under section 684 as having transferred all of its assets to a foreign trust, except to the extent a grantor or another person is treated as the owner of the trust when the trust becomes a foreign trust.

Special Rule for Certain Revocable Trusts

Section 645 provides that the executor of an estate and the trustee of a qualified revocable trust can elect to treat the trust as part of the estate instead of filing a separate Form 1041 for the trust. The election applies to all tax years of the estate ending after the date of the decedent's death and before the applicable date, as defined below. Once made, the election is irrevocable.

Qualified revocable trusts.   A qualified revocable trust for this purpose is any trust or portion of a trust that is treated under section 676 as having been owned by the decedent whose estate is making the election, because of a power in the grantor of the trust to revoke the trust. For this purpose, a power does not include any power in the grantor that is treated as held by the grantor because it is held by his or her spouse.

Applicable date.   The applicable date is either:

• If the estate is required to file a Federal estate tax return, the date that is 6 months after the date of the final determination of the Federal estate tax liability or
• If the estate is not required to file a Federal estate tax return, the date that is 2 years after the date of the decedent's death.

Making the election.   You make the election by attaching to Form 1041 a statement signed and dated by both an executor of the estate and a trustee of the trust that includes the information required by Rev. Proc. 98-13, 1998-1 C.B. 370. The original statement must be attached to Form 1041 filed by the due date (including extensions) for the estate for its first tax year. If the original return was filed on time, you may make the election on an amended return filed no later than 6 months after the due date of the return (excluding extensions). Write Filed pursuant to section 301.9100-2 at the top of the amended return, and file it at the same address you used for the original return.

If the revocable trust is required by Rev. Proc. 98-13 to file a Form 1041 for the tax year ending after the date of the decedent's death, you must attach a copy of the statement to that return.

Also, see Notice 2001-26, 2001-13 I.R.B. 942. This notice allows you to use the election and reporting procedures found in Rev.Proc. 98-13 or the election and reporting procedures in Proposed Regulations sections 1.645-1(c) and 1.645-1(d)(1). Under the proposed regulations, the election is considered made upon the filing of Form 1041 (with the required election statement attached) for the first tax year of the estate, or if there is no personal representative, for the first tax year of the trust filing as an estate. Also, if the election is made the trust does not have to obtain an employer identification number (EIN) for the trust or file Form 1041 for the short year. In such a situation, the trust's income, deductions, and credits are combined with those of the related estate on Form 1041.

Alaska Native Settlement Trusts

The trustee of an Alaska Native Settlement Trust may elect the special tax treatment for the trust and its beneficiaries provided for in section 646. The election must be made by the due date (including extensions) for filing the trust's tax return for its first tax year ending after June 7, 2001. Do not use Form 1041. Use Form 1041-N, U.S. Income Tax Return for Electing Alaska Native Settlement Trusts, to make the election. Additionally, Form 1041-N is the trust's income tax return and satisfies the section 6039H information reporting requirement for the trust.

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