How to Allocate Income on Schedule K-1 for Estates and Trusts
Income earned by a trust or estate that’s paid out to a beneficiary in the same year as it’s earned must be reported to that beneficiary on Schedule K-1, and that income maintains its character when it’s distributed. As trustee or executor, you must know what type of income you’re distributing and in what forms.
Income passes to the beneficiary in the same ratio as it’s earned by the trust or estate. So, if a trust earns 40 percent of its income as interest, 30 percent as dividends, and 30 percent as rental, the numbers shown on Schedule K-1 will reflect those percentages.
The one exception to this rule concerns capital gains. Except in the last year of the trust or estate, capital gains remain trapped at the trust or estate level, which pays all the income taxes due on them. However, if you, as the fiduciary, determine to distribute to a beneficiary the value of certain property, you may elect to have the beneficiary pay the tax on the capital gain generated by the sale.
You arrive at each individual number by dividing the total for each type of income into the total for all types of income includable on Schedule K-1, and then multiplying the result by the amount of the income distribution deduction (IDD) (Form 1041, Schedule B, line 15). Allocations are made across all classes of income, whether taxable or nontaxable.
This table shows a sample, using $10,000 of income, with $7,500 of allowable deductions for professional fees and state income taxes.
|Form 1041||Schedule K-1 Allocation|
|Income Amount||Amount||Income Type||Allocation Calculation||K-1 Amount|
|Interest income||$4,000||Interest||$4,000 ÷
$10,000 × $2,500
|Dividend income||$3,500||Dividend||$3,500 ÷ $10,000 × $2,500||$875|
|Rental income||$2,500||Rental||$2,500 ÷ $10,000 × $2,500||$625|
|Income Distribution Deduction (IDD)||$2,500||Total K-1 Income||$2,500|
Income shown on all the K-1s equals the trust or estate’s IDD, not the amount of the distributions actually paid. So, even when a beneficiary receives more than $2,500, as in this example, he or she only pays tax on $2,500.