Inheritance vs. a Trust vs. IRS Form 1041

[bps2001]

My mother-in law passed away in Nov 2020.  We filed tax returns on her behalf during the last few years as my wife was the Power of Attorney (& fiduciary), was jointly listed on all bank and investment accounts,  and a co-trustee on her mother's revocable trust.  Our understanding was there would be no tax consequence since no transfer of funds occurred (due to joint listing/access on all accounts).  When searching Turbo Tax discussions on filing requirements for deceased individuals, I found the following:

"With the exception of funds inherited in the form of a retirement account (e.g., IRA, 401(k)), an inheritance is generally not taxable on the federal level."

"Revocable trusts (Grantor Trusts) are not required to file Form 1041."

And, it appears the IRS indicates that there are no inheritance taxes on estates less that $11.58MIL (our mother-in law's estate was in the small six figures).

Putting all of this together, why would we have to file a Form 1041 if: a) the estate is less than $11.58MIL; b) the trust was a revocable trust; c) there was no transfer of assets (my wife was a co-trustee and jointly listed on all accounts).  While the Form 1041 instructions make it appear that a Form 1041 must be filed for 2020 (decedent trust requirement for 1099 income > $600), that requirement seems to be in conflict with the above.   And even if my wife liquidates the trust in favor of placing the funds with a different investment firm, wouldn't she be protected from any tax liability due to the $11.85MIL limit, thus eliminating the need for the Form 1041?

[Anonymous_ · Accepted solution]

$11.58 million is the lifetime exclusion from owing estate tax on the value of the decedent's estate.

See https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

A revocable (aka living trust) becomes irrevocable at the death of the grantor and a separate taxable entity. As such, the the trust is required to file Form 1041 if the trust has any taxable income for the tax year or gross income of $600 or more.

See https://www.irs.gov/instructions/i1041#idm140229124997744

[bps2001]

Thanks.  But, this seems like a circular issue.  If one's estate includes all of one's assets, it should be irrelevant whether they are in or out of a trust.  The estate is the estate.  By taxing a trust, which is part of one's estate, the IRS is essentially saying that the $11.58MIL limit "doesn't hold water".  Rather, they can tax any portion of one's estate they want regardless of the $11.58MIL exclusion.  I know you can't solve this regulatory issue - just blowing off a little steam.  Thank for your assistance.

[SamS1 · Accepted solution]

The $11.58 million exemption you are referring to is estate tax, not income tax.  Income earned by the estate assets will pay income tax as long as the assets are generating income after date of death and before the estate is closed.  The 1041 form is to report the income earned from the assets in the estate.  The $11.58 million exemption is related to form 706.  Additionally, the tax rates for trusts and estates are very steep so you will want to distribute out any net income to beneficiaries before the one year is over so the estate income will be taxed at the lower individual tax rates.  The advantage of a revocable trust is the assets bypass probate and the trustor can designate who will receive the assets.

[bps2001]

Thank you for your response.