Schedule K-1 Forms: Managing Your Client’s Estate Income

When helping clients with their estate plan, taxes are one of the key components to take into account as part of the planning process. And while there are several estate planning strategies that can be used to minimize or eliminate estate taxes for clients, here we’ll talk specifically about taxes that an estate or a trust incurs on its income.

One of the forms that clients should be familiar with if they are trustees, administrators, or beneficiaries of an estate or a trust is schedule K-1. Since there are a few different types of K-1 forms, it’s important to understand the type that relates to estate planning so you can help your clients prepare and avoid any tax compliance issues or penalties. So let’s take a look at what a K-1 form is and how to file it properly.

What is a K-1?

A K-1 is a tax form filed to report income, deductions, and credits for pass-through entities. These pass-through entities include estates, trusts, S corporations, and certain types of partnerships such as limited partnerships. 

A K-1 form is filed by the entity or the fiduciary of the entity such as a trustee, an administrator, or an executor of an estate. The K-1 form is then sent to the beneficiaries or shareholders who received income or distributions from the entity. If there are multiple beneficiaries or shareholders, each of them gets their own schedule K-1 which shows the exact amount of income they received.

The beneficiary or shareholder then enters the information from the K-1 on to their Form 1040 when filing their personal income tax return. 

Different types of schedule K-1 tax forms explained

Depending on the underlying entity that a schedule K-1 is generated for, there are three different types of K-1 forms that can be used.

  • K-1 form for estates and trusts: 1041

Schedule K-1 form 1041 is a type of K-1 used specifically for estates and trusts. It is the K-1 tax form that someone may get when receiving an inheritance or if they are a beneficiary of a trust. If your client serves as the executor of an estate, for example, they will use K-1 form 1041 to document and report the income and deductions that were distributed to beneficiaries.

  • K-1 for partnerships: 1065

If your client owns shares in a limited partnership or some exchange-traded funds (ETFs), such as ones that contain alternative assets like commodities or real estate, they’ll receive schedule K-1 form 1065 with details about the income received from this investment.

  • K-1 for S corporations: 1120S

Shareholders of S corporations receive schedule K-1 form 1120S to report their share of income, deductions, and credits related to the activities of the S corporation.

How does a form K-1 work for an estate?

What is a K-1 for taxes specifically related to an inheritance or an estate? And who’s responsible for filing it?

Any income that accumulates in the estate from the underlying assets must be accounted for by the estate. This could include dividend income, short-term capital gains, long-term capital gains, rental income, or income generated from business activities.

While the estate is open and has income-producing assets, tax returns have to be filed for the estate every year to report any income generated. If the income from the estate is distributed to beneficiaries, the beneficiaries are sent schedule K-1 form 1041 generated by the estate to show their share of the distributed income. 

The beneficiaries will then need to include the numbers from this K-1 on their personal tax returns to pay taxes on the estate income received at their corresponding tax bracket.

How do I report income from schedule K-1 form 1041?

If you’re a beneficiary who has received a schedule K-1, you will need to report the income on your personal tax return, IRS Form 1040. You can do this by transferring the details provided on their Schedule K-1 to the relevant sections of your tax return. Many tax preparation programs will do this for you through their question and answer format.

The Schedule K-1 will delineate your portion of income, deductions, and credits from the estate and these numbers will be categorized for easier understanding. 

Note any special instructions or footnotes on the Schedule K-1. These might contain details about specific items requiring different reporting methods. For example, there may be special instructions regarding the treatment of foreign income or passive activity losses.

What deductions can you use to minimize the income for an estate?

Nobody wants to pay more taxes than necessary, especially when it comes to estates and trusts, which generally incur higher tax rates than individuals due to the low thresholds that put estates in the highest tax bracket. 

As of 2024, any income in a trust or estate over $15,200 is subject to a 37% tax rate. Capital gains and qualified dividends over $15,450 are taxed at a 20% rate. This makes it crucial to do proper estate planning and utilize opportunities to reduce estate taxes when possible and legal to do so.

Strategically using deductions can make a significant difference in reducing the tax burden on the estate. Below are some common deductions that the executor can consider to lower the taxable income of an estate.

  • Professional fees: This covers costs like accounting fees for tax prep and other legal expenses during estate administration.
  • Fiduciary fees: These are fees paid to fiduciaries, like trustees or executors, for managing and handling the estate.
  • Court filing fees: Fees paid for court filings, such as probate filing fees, can be deducted as administrative expenses for the estate.
  • Charitable deductions: Donations to qualified charities can be deducted from the estate’s taxable income.
  • Required distributions to beneficiaries: Distributions to beneficiaries as required by the decedent’s will or trust can be deducted from the estate’s taxable income.
  • Losses during administration: Losses incurred during estate administration, such as investment or casualty losses, might be deductible from the estate’s taxable income.

Leveraging these deductions can help you effectively minimize your client’s estate’s taxable income, ultimately reducing the overall tax burden and maximizing the assets available for distribution.

Prepare your clients for the tax implications of income in their estate or trust

Clients should always consult their tax advisor for tax advice or when filing personal, business, or estate tax returns. If you want to help your clients be prepared for the tax implications that their trust or estate might generate for their beneficiaries, you can use an estate planning software like Vanilla to help them visualize different estate planning scenarios. 

Get started with our estate planning checklist to help you gather all the necessary information to start analyzing your client’s estate so you can help them leave a legacy in line with their wishes while minimizing taxes.

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