You can’t walk away from your duties as trustee until and unless you’ve filed a final Form 1041, U.S. Income Tax Return for Estates and Trusts. Before terminating the trust, you will need to ensure that it has reached zero taxable income and zero tax liability. If the trust terminates before the end of a calendar year, you may consider filing a short-year return.
When preparing the final Form 1041, keep the following important points in mind:
Make sure that you tick the Final Return box on the face of the return. And, in case you think the IRS may miss that little box, feel free to also write “Final Return” across the top of the first page.
Make sure that the return shows that the trust has reached zero taxable income and zero tax liability. The zero taxable income is achieved by passing out all items of income and deduction to the beneficiaries and remaindermen on Schedule K-1, and by disallowing the exemption amount that would ordinarily be allowed on a non-final return.
Remember to include all your deductions, even if you don’t have enough income to offset them. Excess deductions on termination of a trust are apportioned and distributed to all the recipients of Schedule K-1. They can deduct them on Form 1040, Schedule A as a miscellaneous itemized deduction subject to the 2 percent adjusted gross income limitation.
Determining any final tax liability
Just because the final Form 1041 shouldn’t have any income tax liability doesn’t mean that you may not still have some outstanding tax obligations, either from a prior year’s return or from a state or local government, or even unpaid real estate taxes. You need to double-check and determine whether the trust has any final tax liability.
In order to make the determination, be sure that you have completed returns for each year of administration and that you have no knowledge of any open issues regarding any of them. Rough out any tax returns still to be completed or filed at the time the trust terminates its income interest. Be sure to segregate any taxes you think you owe before making any payments to income beneficiaries or remaindermen.
Make payments of the taxes the trust owes before you begin making distributions to the remaindermen. If you’re not absolutely certain of the final tax bill, generously estimate the payment, and send it in. If you know exactly how much the trust owes, write that check and get it out of the way. Dealing with a tax refund is far easier than getting the remaindermen to cough up money to settle the trust’s tax liability.
Filing a short-year return
Trusts rarely terminate on December 31. Accordingly, the last year of the trust’s existence will most likely be a short year (less than 12 months). Using a short-year return allows you to conclude the trust’s business in a timely fashion. Short-year returns are prepared just like any other return, with two exceptions:
You’re allowed to use the prior year’s tax form if the current year’s form isn’t yet available. If current year forms aren’t yet available, you may want to superimpose the correct year over the printed prior year.
You must fill in the dates of the short year at the top of the return.
If you opt to use a short year for the final return, don’t forget that the return is still due three and one-half months after the end of the year you’ve chosen. So, if you elect to end the year on November 30, your short-year return is now due on March 15, not April 15.
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Source:http://www.dummies.com/how-to/content/how-to-submit-a-trusts-final-income-tax-returns.html
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