Roth IRA Conduit Trust and filing Form 1041
I have established a Roth IRA Conduit Trust with my grandchild being the beneficiary upon my death. My grandchild is to receive the required minimum distribution each year, and the trustee has the right to withdraw trustee fees as well as the discretion to distribute additional funds for education or health for my grandchild. It is my understanding that the trustee does NOT have to file Form 1041 for the Roth IRA Conduit Trust — is that correct? If not, what are the circumstances/situations where a Form 1041 (and concomitant Schedule K-1) must be filed for the Roth IRA Conduit Trust? (I have researched this issue without much success; I have found one commentator who states that income to the Trust [u]would likely to be considered principal of the Trust [/u]and is not required to be reported on Form 1041. My research is silent regarding capital gains.) Any help on these issues would be appreciated
Permalink Submitted by Peter Lingane on Thu, 2012-02-09 15:55
I see no reason that a Roth IRA Conduit Trust should not be subject to the same reporting requirements as other trusts: a tax return is required if gross income exceeds $600 or if taxable income exceeds zero. That being said, the receipts received by the trust are probably tax free and income and gains on accumulated trust assets are unlikely since it is your intent that all receipts (net of expenses) be distributed. Thus gross income is arguably zero, taxable income is likely zero and no Form 1041 would be required.
I use the word “receipts” because the meaning is clear. The meaning of “principle” and “income” in the trust context is defined within the document or by state law. The uniform principle and income act defines 10% of each IRA distribution as income and 90% as principle but Michael Jones argues that that distributing only 10% of each required distribution to the surviving spouse in the QTIP context is unlikely to withstand challenge.
How are the distribution requirements in your trust phrased? If the document says “receipts net of expenses” are to be distributed, the beneficiary would receive most of each required distribution. If, however, the document says “income net of expenses,” the beneficiary might be entitled to less than one tenth of each required distribution. The trust would be “complex” in the first instance and “simple” in the second.
Permalink Submitted by mk foss on Thu, 2012-02-09 17:49
Small clarification to Peter’s post. Rev Rul 2006-26 denies a marital deduction to a QTIP trust that only pays 10% of an RMD to a surviving spouse. The Uniform Principal and Income Act was changed to define the income from an RMD as a 4% unitrust amount – the amount blessed by Rev Rul 2006-26. CA adopted the new rule shortly after the change and I don’t believe many states are using the 10% income/90% principal rule from the early 2000’s.
Income is now 4% of the prior year 12/31 balance for trust agreements that do not define income. It is always better to provide a definition of income in the trust agreement rather than relying on state law – which can change as mentioned above.
Permalink Submitted by Peter Lingane on Thu, 2012-02-09 18:57
Thank you Mary Kay.
Permalink Submitted by Bruce Steiner on Thu, 2012-02-09 23:31
It doesn’t matter what’s income and what’s principal for trust accounting purposes. The beneficiary is a grandchild, so it won’t qualify for the marital deduction; and the trust does not distinguish between distributions of income and distributions of principal.
However, the dispositive provisions don’t make sense, and in a sense are inconsistent. On the one hand, you’re requiring that any required distributions from the IRA be distributed to the grandchild, regardless of whether the grandchild needs them, or there is some reason (such as creditors, divorce, a taxable estate, a second husband or wife who might claim an elective share, Medicaid) that such a distribution is inadvisable. On the other hand, you’re limiting distributions in excess of the required distributions from the IRA to specified purposes. Why not give the trustees discretion over distributions?
In particular, in a conduit trust, if the grandchild lives to life expectancy, nothing will be left in the trust. All of the assets that could have been kept out of the grandchild’s estate and protected against the grandchild’s creditors and spouses will be thrown into the grandchild’s estate, and will be exposed to the grandchild’s creditors and spouses.
One of the tradeoffs of having a trust as beneficiary of a traditional IRA is that trusts reach the top (currently 35%) Federal income tax at about $12,000 of income, so that there is often an income tax cost in order to accumulate income in the trust. But that’s not a concern with a Roth IRA, since distributions from the Roth IRA are tax-free.
Whether the trust has to file fiduciary income tax returns shouldn’t drive the decisions.
For more on trusts as beneficiaries of retirement benefits, see my article on that subject in the March 2004 issue of BNA Tax Management’s Estates, Gifts & Trusts Journal: http://www.kkwc.com/docs/AR20041209132954.pdf .
Permalink Submitted by mk foss on Fri, 2012-02-10 07:01
Quite often a trust agreement will indicate that all of the income is to be distributed. When we prepare form 1041 for a trust, we inquire as to what was distributed. Income is trust accounting income as defined in the trust agreement. When the agreement is silent, we look to state law. Often the trustee looks to a professional for guidance as to what can be distributed. As Bruce has indicated a beneficiary is taxed on distributions regardless of the source but we will point out to the trustee if they are distributing more or less than the trust agreement provides. It’s a litigious society and being a trustee isn’t always easy.
However, in this situation Forms 1041 may not be required. If the trust agreement says that income is to be distributed and RMDs are income, the $100 filing requirement will not be met if Roth distributions are the only source. The trustee must still fulfill whatever accounting requirements the state law or the agreement impose even if no tax returns are required.
Permalink Submitted by Bruce Steiner on Fri, 2012-02-10 14:16
Except in the case of a marital (QTIP) trust, it rarely makes sense to require that the income be distributed. It’s generally better to let the trustees decide. The trustees can still distribute the income if they think it’s best to do so. But at least the trustees will have discretion not to distribute all of the income if there’s some reason that distributing the income would not be advisable. For example, the beneficiary could have a creditor problem, be getting divorced, have a taxable estate, be on Medicaid, have outlived his/her spouse and remarried and want to limit what his new spouse can claim at his/her death.
Permalink Submitted by Peter Lingane on Fri, 2012-02-10 18:50
The Uniform Principle and Income Act (NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS February 9, 2009) has retained the the rule that 10% of required IRA distributions are income for trusts which are not intended to qualify for the marital estate tax deduction. California Probate Code 16361, as Mary Kay indicated, has modified the uniform code to say that IRA distributions to a trust are generally allocated to income until distributions exceed 4% of the value of the IRA account as of the end of the prior accounting period.
Distributions in excess of the minimum required distribution are allocated to principle and the amount that is required to be distributed to the trust from the IRA is not affected.
The amount distributed to the beneficiary of an IRA conduit trust depends on what the trust says and, if the trust is silent, on the LOCAL UPIA. The beneficiary is entitled to all of the RMD if the trust speaks of receipts, to all of the RMD to about age sixty if the trust speaks of income and the 4% rule applies and to 10% of the RMD if the trust speaks of income and the 10% rule applies.
I endorse earlier comments that it is best to have the document say what you intend.
My suggestion is to seek competent local advice.