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Orphans’ Court Update

May 20, 2014

Requesting, Obtaining and Reporting the Personal Information of the Beneficiaries of a Trust

by Andrew S. Rusniak

With another tax season recently behind us, the Internal Revenue Code and its many reporting requirements are fresh in our minds. Do you encounter beneficiaries who want to know why you need so much of their personal information (including social security numbers) when preparing returns or K-1s?

The Internal Revenue Code of 1986, as amended (the “Code”), requires the trustee of a trust to request, obtain and report certain sensitive information of beneficiaries. With the threat of identity theft  as prominent as ever, it may not be entirely surprising that beneficiaries are sometimes hesitant to readily provide this information. As a result, it is helpful to have an understanding of the framework that underlies a trustee’s obligation to request, obtain and report the personal information of the beneficiaries of a trust.

A non-grantor trust is a separate legal entity for federal tax reporting purposes; as a result, a trust is required to file a Form 1041 to report the income, deductions, gains, losses and credits of a trust. In general, § 643 of the Code provides that income earned by a trust in a tax year is taxable to the trust unless it is distributed to the beneficiaries. This concept is known as “distributable net income” or “DNI” and creates a presumption that any distribution made from the trust to a beneficiary is deemed to come first from the income of the trust. For example, if a trust receives $10,000 of dividend income in one year and distributes that income to the beneficiaries, it is the beneficiaries, rather than the trust, who will pay tax on that income. Similarly, when a trust terminates it will distribute all of its income and principal to the beneficiaries, and the beneficiaries will be required to pay tax on the taxable income received. The terminating trust will be required to file a final income tax return and report a distribution of all taxable income to the beneficiaries, but the trust itself will not pay the tax. Rather, the trust will issue a Schedule K-1 to each beneficiary to report the appropriate amount of taxable income received by the beneficiary.

Section 6109(a)(3) of the Code provides that when required by the Treasury Regulations, “[a]ny person [i.e. the trustee] required …to make a return, statement, or other document with respect to another person [i.e. the beneficiaries of a trust] shall request from such other person, and shall include in any such return, statement, or other document, such identifying number as may be prescribed for securing proper identification of such other person.” Treas. Reg. § 301.6109-1(b)(1) provides that “[a] U.S. person [i.e. the U.S. beneficiaries of a trust] whose number must be included on a document filed by another person [i.e. the trustee] must give the taxpayer identifying number so required to the other person on request.” Treas. Reg. § 301.6109-1(a)(1) defines “taxpayer identifying number” to mean, in the context of an individual, a social security number.

With regard to a trust, § 6012(a)(4) of the Code requires a trust having taxable income of $600 or more to file a tax return for the taxable year. Section 6034A of the Code requires the trustee of the trust to provide each beneficiary with “a statement containing such information required to be shown on such return as the Secretary may prescribe.” The return prescribed by the Secretary for the reporting of a trust’s taxable income is IRS Form 1041, and the Schedule K-1 is made a part of that return. The instructions promulgated by the IRS for the completion of the Form 1041 provide that “[a]s the payor of income, the trust is required to request and provide a proper identifying number for each recipient of income. Enter the beneficiary’s number on the respective Schedule K-1 when you file the Form 1041. . . [The trust] may be charged a $100 penalty for each failure to provide a required TIN, unless reasonable cause is established for not providing it. Explain any reasonable cause in a signed affidavit and attach it to this return.” The method by which a trustee typically requests a taxpayer’s identifying number (i.e. the beneficiary’s social security number) is through the issuance of an IRS Form W-9 to the beneficiaries.

These reporting requirements make clear that the trustee is required to request, obtain and report the personal information (including social security numbers) of the beneficiaries. The Code and the Treasury Regulations may impose penalties upon a beneficiary who fails to provide a social security number pursuant to a valid request, and even a trustee may be subject to penalties in certain instances when a return is filed without the social security numbers of the beneficiaries. Although a beneficiary may be hesitant to readily provide such sensitive information upon request, the disclosure of the beneficiary’s social security number is not optional. A trustee who is having difficulty obtaining a beneficiary’s required information should make every effort to explain the reporting requirements and obligations found in the Code and Treasury Regulations. If a beneficiary simply refuses to provide the requested information, and if the trustee is otherwise unable to obtain it, the trustee should attach a signed affidavit to the Form 1041 establishing reasonable cause for the failure to report the beneficiary’s social security number.

© 2014 McNees Wallace & Nurick LLC
ORPHANS’ COURT UPDATE is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.