One of the benefits of a living or revocable trust is that it allows an individual to remove property from his or her probate estate by transferring the property to a trust. Because the trust, and not the decedent, owns the property at death, the property passes under the terms of the trust and outside probate. One question I frequently get is, “What are the complications associated with transferring the property to the trust during life, and particularly, does the trust have to file a separate tax return?” The living trust usually does not file a separate tax return. Under the Internal Revenue Code, a revocable trust qualifies as a “grantor trust.” Under the Grantor Trust Rules, the trust is “disregarded” and all the items of income or expense are reported on the Grantor’s Form 1040, as if the trust did not exist for tax purposes, as long as the trust retains its “grantor trust” status.
In order to report on Form 1040, the grantor and/ or trustee must comply with a couple of fairly simple requirements. Form W-9 (the form that individual taxpayers use to provide third parties with the taxpayer’s Social Security number) must be provided to the property manager with the grantor’s name and Social Security number. The EIN (Federal Employer Identification Number) of the trust is not used. When property managers make payments to the trust, they issue a Form 1099-Misc to the grantor that reflects the rental payments made to the trust during the tax year. The grantor reports the payments made to the trust, and reflected on the form 1099, on his or her form 1040 individual income tax return. That way, the rental income items are paid to the trust but are reported by both the payer and the grantor to the IRS under the grantor’s Social Security number. These rules apply even if the grantor is not serving as trustee of the trust.
If the grantor of the trust is a foreign citizen, then you would have them fill out form W-8ECI (Certificate of Foreign Person’s Claim That Income Is Effectively Connected with the Conduct of a Trade or Business in the United States) instead of the form W-9. They would receive a 1042-S form (Foreign Person’s U.S. Source Income Subject to Withholding) instead of a 1099-Misc to report the annual rents. The foreign citizen would need an ITIN (Individual Taxpayer Identification Number) or a U.S. Social Security number to complete form W-8ECI or we would have to withhold a 30% deposit on the gross rental income and submit it to the IRS as a tax deposit.
By Richard Hart, EA. CAA, Hart & Associates, National Association of Residential Property Managers Affiliate Member