11.15 How Beneficiaries Report Estate or Trust Income

Trust or estate income is treated as if you had received the income directly from the original source instead of from the estate or trust. This means capital gain remains capital gain, ordinary income is fully taxed, and tax-exempt income remains tax free. Tax preference items of a trust or estate are apportioned between the estate or trust and beneficiaries, according to allocation of income.

Your share of the trust or estate income, deductions and credits is reported by the fiduciary on Schedule K-1 of Form 1041. You do not file Schedule K-1 with your return; keep it for your records. The instructions to Schedule K-1 indicate where to report the trust or estate items on Form 1040. For example, capital gains are reported on Schedule D, as are other capital gains. Income or loss from real estate or business activities shown on Schedule K-1 is reported by you on Schedule E, subject to the passive activity restrictions discussed in Chapter 10.

Filing Instruction

Consistent Reporting by Beneficiaries

Beneficiaries of trusts and estates must report items consistently with the Schedule K-1 provided by the trust or estate. If an item is treated inconsistently and a statement identifying the inconsistency is not attached to the return, the IRS may make a summary assessment for additional tax without issuing a deficiency notice.

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Reporting rule for revocable grantor trusts.

A grantor who sets up a revocable trust or keeps certain powers over trust income or corpus must report all of the trust income, deductions, and credits. This rule applies if a grantor retains a reversionary interest in the trust that is valued at more than 5% of the trust (valued at the time the trust is set up) (39.6). If a grantor is also a trustee of a revocable trust and all the trust assets are in the United States, filing Form 1041 is not necessary. The grantor simply reports the trust income, deductions, and credits on Form 1040. See the Form 1041 instructions for reporting requirements.