A trust is a financial entity set up to shelter assets from probate court, or to control the use of funds by a trustee for a specific purpose. The Internal Revenue Service normally taxes dividends received by individuals as either ordinary income, taxed at whatever the individual's personal rate may be, or at a lower rate reserved for "qualified" dividends. However, if the dividends are paid into or out of a trust, there are a few special reporting conditions.
Reporting Dividends on Form 1041
The IRS requires a tax return if a trust earns more than $600 in gross income, if any of the trust income is taxable or if any beneficiary is a nonresident alien. Trusts report their income and expenses on Form 1041, U.S. Income Tax Return for Estates and Trusts. The trustee or fiduciary preparing the return enters the amount of ordinary dividends it receives on Line 2a; this amount is part of the total gross income on Line 9. If the dividends are "qualified," then the amounts go on lines 2b, (1) for beneficiaries and (2) for the estate or trust.
A "qualified" dividend is one paid by a U.S. or qualified foreign corporation, on stock the trust holds for at least 60 days in the 121-day period before the ex-dividend date (after which new stockholders will not receive the dividend). If the trust buys stock a few days before a dividend record date just to capture the dividend, for example, then it's receiving an ordinary, not qualified, dividend. For individuals as well as trusts, qualified dividends are taxed at the same rate (either 0 or 15 percent) as long-term capital gains.
Distributions to Beneficiaries
The IRS does not tax a trust for dividends that it distributes to its beneficiaries, whether that dividend payout is required by the trust document or not. Instead, the beneficiary is liable for taxes on these dividends. The payments to beneficiaries are reported by the trustee on Form K-1, copies of which must be sent to the beneficiary and attached by the trustee to Form 1041. On the Form K-1, the trustee reports qualified dividends on Part III, Line 6a, and ordinary dividends on Line 6b.
A beneficiary reports dividends received from a trust on his individual tax return, Form 1040. Qualified dividends go on Line 9a, while ordinary dividends go on Line 9b. If a beneficiary receives more than $1,500 in interest and ordinary dividends (from all sources), then he also must file Schedule B. The IRS also requires Schedule D if a beneficiary is reporting any capital gains. The qualified dividends join the long-term capital gains amount; the ordinary dividends join the gross income reported on Line 9 of Form 1040.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.