Life Insurance with only beneficiary of a living trust where beneficiaries are listed...

[Scott G1]

Our mother passed away leaving a living trust that contained many things in 2003 when it was last updated but 8 of the 9 items listed in Schedule A have long been liquidated or closed. The only item that was still there was a $100,000 life insurance policy with policy number and specific distribution directions.

The life insurance policy had only one beneficiary which was the living trust (now irrevocable). I have worked through the EIN and setting up the trust bank account. The life insurance company and bank have both reviewed the trust documentation allowing for the death benefit of the life insurance to be wired to the trust bank account. I opened the bank account with $1000 from my personal checking just to get something in there when opening the account. So far, everything is very clean it seem.

Understanding that our mother paid a significant premium for 32 years on this life insurance with post income tax money of course, I want to confirm that as I write the disbursement checks to the other siblings as per the specific instructions in trust document that I can assure them that they will not be taxed on the disbursement but I am not finding any way to fill out the 1041 / K-1 forms that specifically explains that this is NOT income disbursements. As the trustee / fiduciary, I'm very concerned that I have not been able to get a confirmation on how to fill these forms out to make sure they do not get a huge tax burden in early 2025.

Had the beneficiaries been directly listed on the life insurance policy there is no doubt it would not be taxable. It makes no sense that a trust that essentially contains ONLY this life insurance policy with beneficiaries listed there instead of directly on the life insurance policy itself should not turn this from nontaxed inheritance to taxable income or something is very wrong with our tax system. My gut tells me that not even the IRS is this terrible but I cannot seem to find the method to fill out the final 1041 and issue the K-1 to the beneficiaries as principle distributions rather than "income".

Any help is welcome here. I will be paying for the desktop business edition of TurboTax next year so I can do these forms.

Thank you in advance for all input for us and more than likely others that have this exact scenario also.

[dmertz · Accepted solution]

"So far, everything is very clean it seem."

Except that it seems that there was no reason to deposit $1,000 of your own money into the estate account.  That $1,000 should probably come back to you.

If your mother was the insured and the policy is paying the death benefit, there is no taxable income to pay to the beneficiaries, so no taxable income from this insurance payout to enter as Other income (Form 1041 line 😎 or to report on Schedules K-1.  Only the taxable amount shown in box 2a of the From 1099-R would be entered as Other income.  There would only be taxable income from this if the money earned interest while in the estate account.

[Scott G1]

I agree that the best / cleanest way to handle this would have nothing but the Life Insurance Benefit money in the Trust account but that was not really possible or offered by the bank when opening the account.  Effectively, the Life Insurance company required verification of a valid "trust bank account" before they would even begin processing the claim.   The bank required a minimum of $600 or more to open the account and to open the account, they too had to review the trust documentation as well as the newly created EIN.   Rather than try to convince a bank to open an account with no money, I just pulled $1000 of my own money out in cash to open it with cash (I have receipts for both transactions).   Hopefully that $1000 account opening money will not be a huge issue. 

[dmertz]

I don't see the $1,000 as being a problem.  I just seeing it as meaning that you are a creditor with respect to that amount and should be reflected in the accounting.

[Scott G1]

It will be clearly noted in several ways for tax season.  Also there will be 7 total transactions for the 2 month or so life span of this Trust bank account before closing.

1) Opened with $1000 cash

2) Received Life Insurance Benefit

3) Beneficiary 1 check clears for 25% (per disbursement directives in Trust document)

4) Beneficiary 2 check clears for 25% (per disbursement directives in Trust document)

5) Beneficiary 3 check clears for 25% (per disbursement directives in Trust document)

6) Beneficiary 4 check clears for 25% (per disbursement directives in Trust document)

7) After all checks clear and account back at $1000, I as the Trustee will close account taking $1000 back as cash to deposit in my account.

The only issue is can I make this clear enough to the IRS that these are life insurance beneficiaries via the 1041 form and the issued K-1 forms.  If I can, they should be tax exempt.

[VolvoGirl]

When we sold our parent's house and put it in the Trust then disbursed it the Trust paid the taxes.  The  Accountant EA did the final Trust return and did not issue  K-1 forms since the Trust paid the tax.  

[Scott G1]

That would make sense for a house.   This situation is strictly limited to the trust ONLY distributing life insurance proceeds to the beneficiaries.   Nothing else exists in the trust any more (it was last amended in 2003).   When it was last amended our parents did have their house, cars, bank accounts, IRAs and even a time share (ouch!) but all of those items are long gone.  The last one was closed, sold or liquidated over 12 years ago.   Unless you have very young children or have very specific ways you want to have your life insurance disbursed to the beneficiaries, there seems to be no real benefit to putting your life insurance in your living trust then putting the beneficiaries in the trust with disbursement percentages.   I guess the only other reason to do this is if the Grantee had a HUGE estate where they wanted to keep the life insurance benefit out of their estate valuation.  As our mom passed at almost 91 with really no actual estate due to 3 years of going broke living in assisted living then in 2020 I built a full handicap addition for her to move in so she could live her last four years with family and pets for basically nothing other than the cost of her in home help 4 hours a day.   Her estate consisted of her checking / saving, and IRA with direct beneficiaries listed specifically and her life insurance pointing to the trust. 

[VolvoGirl]

I was just pointing out that there were not any K-1s issued at all from the Trust since nothing was passed on to the beneficiaries except for the final disbursements.  

[tagteam]

---

@Scott G1 wrote:

The only issue is can I make this clear enough to the IRS that these are life insurance beneficiaries via the 1041 form and the issued K-1 forms.  If I can, they should be tax exempt.

---

@dmertz is correct on this issue.

If you're only distributing life insurance proceeds, then you're essentially distributing corpus (nontaxable proceeds from a life insurance policy). Those proceeds are not included in gross income, regardless.

See https://www.law.cornell.edu/uscode/text/26/101

There should be no need to issue K-1s to report the distributions.

[Scott G1]

It sounds like I will still need to fill out a 1041 for the trust bank account that was opened and closed in 2024 but because all distributions to beneficiaries would be tax exempt thus removing any need for the K-1 notices to the beneficiary.  I'm sure that would be the best case scenario for all beneficiaries.

I am wondering if someone at Turbotax Biz support would allow us to do a mock 1041 using the Biz Desktop 2024 Turbotax edition to see how to enter it in the software next year.    If I could buy the 2025 Desktop Home and Business version right now, I would do it just to put this info in to see how it works out.  To my knowledge the rules are the same in 2024 but may expire if a certain person / party get's elected in November. 

[tagteam]

That would be doubtful, @Scott G1, since the 2024 software is not available.

[VolvoGirl]

You have the years mixed up.  The current program is 2023 for 2023 returns.  So you would want to use 2023 to do a mock 2024 return.  Next year in 2025 you can buy the 2024 program (actually it should go on sale in November 2024).

If you want to buy 2023 now to test.......You can buy the stand alone do it yourself Business CD/Download program for Windows here (it is not available to do online or for Mac). There are 2 ways to buy it. If you want a CD you need to pick the Advantage Plan in the right box.
https://turbotax.intuit.com/small-business-taxes/cd-download

[tagteam]

---

@Scott G1 wrote:

.......do a mock 1041 using the Biz Desktop....

---

Why? If the trust only had proceeds from a life insurance policy, which proceeds are specifically excluded from gross income (see https://www.law.cornell.edu/uscode/text/26/101), there is most likely no need to even file a 1041.

[Scott G1]

The only reason for the 1041 would be the fact that I had to create an EIN # for it notifying the IRS of it's existence.  If I do not file a 1041 noting "final return", the IRS will assume the trust is still open after 2024 when in fact it was opened and closed in a matter of 3 or 4 months in 2024.  As the trustee, I want to be finished with this trust after 2024 and not have an open EIN associated with my social sec in 2025 and beyond.   Sorry but all this is new to me and I'm not loving being the "trustee" lol.