Mexican Land Trust / Fideicomiso

A U.S. person typically owns Mexican real estate near the coast or the border through a Mexican Land Trust (a.k.a., fideicomiso).  It was widely believed that the IRS considered a Mexican Land Trust to be subject to the foreign trust information filing requirements, such as IRS Forms 3520 and 3520-A.  In a recent ruling (Rev. Rul. 2013-14), the IRS has officially acknowledged what seemed obvious to many tax experts: there is no “trust”.  Just because something is called a “trust” (“fideicomiso”) doesn’t mean it is taxed as a trust.  Under U.S. income tax law, a trust is an arrangement created by a declaration (will or trust document) where one person (fiduciary or trustee) takes ownership of property in order to protect or conserve it for another person (beneficiary).  Where the Mexican fiduciary, usually a Mexican bank, has no rights or obligations beyond simply holding title to the property in place of the U.S. person, there exists no trust under U.S. income tax law, so there are no foreign trust reporting requirements for the fideicomiso. 

© Michael Fitzsimmons, CPA, San Diego, CA http://fitz-cpa.com/

How is a the Income of a Decedent’s Estate Taxed?

Many people know that the estate tax applies only to estates of several million dollars, but that doesn’t mean that an estate has no tax obligations. An estate must file an income tax return and, depending on the timing of distributions, pay income tax. Typical items of taxable income include interest, dividends, and capital gains. An estate reports income and deductions similarly to a complex trust on IRS Form 1041. However, there are some important differences, such as choice of fiscal year, quarterly estimated tax payments, and rental real estate losses. Often a person dies with assets held in a revocable trust and some or all of the trust becomes irrevocable upon death. Typically this results in the creation at death of two taxable entities, the decedent’s estate and the irrevocable trust. If proper procedures are followed, income tax law allows these two entities to be combined for income tax return purposes. This usually results in more favorable tax rules, and, since only one income tax return is required per year, saves on professional tax preparation fees.

When is a Trust Income Tax Return, Form 1041, Required?

For income tax purposes, the IRS does not recognize that a trust exists when it is revocable. Accordingly, all of a revocable trust’s income and tax deductions are reported on the grantor’s personal income tax return. No trust income tax return, IRS Form 1041, needs to be filed unless the trustee is someone other than the grantor. Because of this, a revocable trust typically does not need to obtain a tax identification number, or FEIN (Federal Employer Identification Number). When a revocable trust turns into an irrevocable trust, which typically occurs when the grantor dies, a trust income tax return, IRS Form 1041, usually must be filed each year. However, no trust income tax return is required if all of these conditions are met: there is no taxable income, gross income is less than $600, and there is no nonresident alien beneficiary. When a trust tax returns is filed and there is a distribution or deemed distribution to a beneficiary, the beneficiary receives a Schedule K-1 showing the share of income and tax deductions. http://fitz-cpa.com/trust_estate.aspx

Trust Modification – Court-Approved

In a recent private letter ruling, the IRS determined that a court-approved modification of a revocable trust created by a decedent and spouse doesn’t provide the surviving spouse with a “general power of appointment”. Therefore, the value of assets in by-pass trust won't be included in surviving spouse's gross estate. Trust assets were to be divided upon death of first spouse among by-pass trust, marital trust, and survivor's trust. (PLR 201002013)

Trust Income Tax Return Distributions – 65-Day Rule

Since trust income tax rates are generally higher than the beneficiaries’ income tax rates, it is often beneficial to have the income taxed to the beneficiaries rather than the trust. Unique to trust income tax returns (IRS Form 1041), the concepts of fiduciary accounting income distributable net income affect who is liable for the tax. Typically, a trust must distribute income to beneficiaries in order for it to be taxed at their (usually lower) rates. However, a special provision in the trust income tax law allows the fiduciary to elect to treat some or all of the distributions made in the first 65 days of the following tax year as if they were made in the preceding tax year. So if there were not enough distributions in 2009 to cause all of the estate or trust income to be taxed to the beneficiaries, fiduciaries should consider making this tax election. These are the trust income tax rules applicable to trusts taxed as “complex trusts” and also generally apply to a decedent’s estate income tax return, which is made on the same IRS Form 1041, but do not apply to what is considered a “simple trust” under tax law.

As in much of the tax law, there is some gray area that allows for planning / wiggle room. The pertinent trust income tax return law uses the term “properly paid or credited”. The trust income tax return regulations are unclear as to what “properly credited” means and the Tax Court has allowed distributions that were made after the 65-day period where they were shown to be “credited”. Nonetheless, the prudent action is actually pay the distributions within the first 65 days of the estate or trust’s tax year.

Although the foregoing applies equally to California trust income tax returns, the structure of the tax rates applicable to California trust income tax returns differs such that the issue is usually mute.