Family Trust

[gman]

Has a farm and reported income on sch F. Gov payments recieved. Is their any kind of self employment tax to be paid by the trust??

[Koss]

Trust Return

Generally, no. A trust is not subject to self-employment tax.

Whether the income is subject to self-employment tax is a different question. There is no easy answer. I've struggled with this issue myself.

Is the income going to pass through to the trust beneficiaries on Schedule K-1?

BMK

[gman]

No

No, the trust income is not going to flow thru. Could it possibly be listed on form 4835 or E?

[Koss]

Trust Income

If it is not flowing through, then that implies that the trust has retained the income, and that the income will be taxable to the trust, and not to the beneficiaries.

The conundrum is that no matter where you report it on the 1041, it will not generate self-employment tax. The IRS instructions for Form 1041 do not countenance self-employment tax in any way. There is no reference to Schedule SE.

A trust can file a Schedule C to report "business income." Even in this case, the instructions say nothing about self-employment tax or Schedule SE.

In fact, even if you file a Schedule C with the 1041, and distribute the income to a beneficiary, it still doesn't generate self-employment tax--not even for the beneficiary. The income from the K-1 does not flow to a Schedule C on the beneficiary's return--it winds up buried on page 2 of Schedule E.

This doesn't mean the income isn't subject to SE tax. It may be. We would have to look closely at the character of the income, and review the applicable section of the Code.

But the tax forms don't seem to be able to handle the concept.

BMK

[Koss]

Trust Issues

In an effort to combat abusive trust schemes, the IRS has often taken the following position:

The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business.

This may or may not be applicable to your client's situation. I don't have a citation to the regulations.

It is certainly true that some trusts have been established for purposes of tax evasion, and this would appear to include evasion of self-employment tax or FICA.

My private opinion is that this assertion by the IRS is too broad, and it is a case of the tail wagging the dog.

If a trust operates a business and the grantor, fiduciary or beneficiary is involved in the daily operation and management, then the income should in fact be subject to FICA. But you don't have to treat the trust as some other type of entity in order to accomplish this. There should be a way to do this without having to file a corporation or partnership return, for heaven's sake.

It should be possible for the trust itself to pay the FICA tax, or for the income to pass through to a beneficiary and flow to a Schedule C...

But the tax forms don't seem to be set up to allow this.

BMK

[Burke]

If you mean there is not a line on the K-1 for Form SE you are correct. But a business or a farm's net income would show up on 1041 Line 3, and pass thru to the K-1 (if there were distributions) to its Line 6. This goes to Sche E, as you said. You would then determine if, in fact, it was an item that should be subj to SE tax, based on the information posted above, and that amount would go on Line 14 of the K-1 under "Other Information," Code H, with an explanation. You would have to manually input that. I am not sure how any software would be able to make that determination, unless it specifically asked the question about material participation. Then the bene would have to complete Sche SE on his own return, much the same as completing it for an item on the 1040 listed on Line 21 subj to SE tax. Now, the trust could give the bene credit for estimated taxes on Line 13A of the K-1 if the trust document allowed that. He would use that to apply against his own final tax liability -- income tax and self-employment tax.

[gman]

Thank

you all for your help.