CES Documentation & Legal Requirements 3 — Questions and Answers
Question 1: Which IRS form must a trustee file annually for a domestic trust that has taxable income or gross income of $600 or more?
- Form 1041 (Correct answer)
- Form 1065
- Form 5227
- Form 990-PF
Correct answer: Form 1041
Form 1041 (U.S. Income Tax Return for Estates and Trusts) is the annual income tax return required for domestic trusts and decedents' estates.
Question 2: A decedent's estate includes a farm valued at $8 million. Which provision may allow the executor to value the farm based on its agricultural use rather than highest and best use?
- IRC Section 2032 Alternate Valuation
- IRC Section 2032A Special Use Valuation (Correct answer)
- IRC Section 6166 Installment Payment
- IRC Section 2036 Retained Interest Rule
Correct answer: IRC Section 2032A Special Use Valuation
IRC Section 2032A permits qualifying real property used in farming or a closely-held business to be valued at its current use rather than fair market value, reducing estate tax.
Question 3: What document must a trustee provide to trust beneficiaries that details income, deductions, and distributions allocable to each beneficiary for federal income tax purposes?
- Schedule K-1 (Form 1041) (Correct answer)
- Form W-2
- Form 1099-INT
- Schedule E (Form 1040)
Correct answer: Schedule K-1 (Form 1041)
Schedule K-1 (Form 1041) reports each beneficiary's share of the trust's income, deductions, and credits so beneficiaries can report them on their individual returns.
Question 4: Under the Uniform Prudent Investor Act, what is the primary duty of a trustee when setting investment policy?
- Maximize current income for income beneficiaries
- Invest solely in government-backed securities
- Diversify investments and balance interests of all beneficiaries (Correct answer)
- Follow the specific instructions of the trust grantor regardless of market conditions
Correct answer: Diversify investments and balance interests of all beneficiaries
UPIA requires trustees to diversify trust investments and to balance the competing interests of current income beneficiaries and remainder beneficiaries within an overall investment strategy.
Question 5: A grantor retains the right to revoke a trust. Under the grantor trust rules, who is taxed on the trust's income?
- The trust itself at trust tax rates
- The income beneficiary
- The grantor (Correct answer)
- The remainderman
Correct answer: The grantor
Because the grantor holds the power to revoke the trust, IRC grantor trust rules treat the grantor as the owner of the trust assets, making the grantor responsible for income tax.
Question 6: Which federal law requires financial institutions to verify the identity of trust account holders and beneficial owners as part of anti-money laundering compliance?
- Employee Retirement Income Security Act (ERISA)
- Bank Secrecy Act (BSA) / Customer Due Diligence Rule (Correct answer)
- Uniform Fiduciary Income and Principal Act (UFIPA)
- Gramm-Leach-Bliley Act
Correct answer: Bank Secrecy Act (BSA) / Customer Due Diligence Rule
The Bank Secrecy Act's Customer Due Diligence Rule requires financial institutions to identify and verify beneficial owners of legal entity accounts, including trusts, to prevent money laundering.
Question 7: What is a 'Certificate of Trust' primarily used for in estate planning practice?
- To register a trust with the IRS for a tax ID number
- To provide third parties with proof of a trust's existence and trustee authority without disclosing full trust terms (Correct answer)
- To record the trust document in the county land records
- To notify beneficiaries of their interests under the trust
Correct answer: To provide third parties with proof of a trust's existence and trustee authority without disclosing full trust terms
A Certificate of Trust is an abbreviated document that confirms a trust exists, identifies the trustees, and outlines their powers, while keeping sensitive beneficiary and distribution provisions private.
CES Documentation & Legal Requirements 3
Which IRS form must a trustee file annually for a domestic trust that has taxable income or gross income of $600 or more?