Who must file Form 1041-A?

A common misconception is that only trusts described in Sec. 4947 (a) (2) (i.e., "split-interest" trusts) must file Form 1041A. However, trusts claiming a charitable income tax deduction under Sec. 642(c) must also file Form 1041-A. Due to the applicable penalties, failure to file Form 1041-A can have serious consequences.

Statutory Filing Requirement

Sec. 6034, titled "Returns by Trusts Described in Sec. 4947(a) (2) or Claiming Charitable Deductions Under Sec. 642(c)," and Regs. Sec. 1.6034-1 (a) provide that the following trusts (with two exceptions) must file Form 1041-A:

[] Every split-interest trust described in Sec. 4947(a) (2) (unless all transfers to the trust occurred before May 27, 1969); and

[] Any trust claiming a charitable deduction under Sec. 642 (c).

As a result, the following trusts are required to file Form 1041-A annually:

[] Charitable remainder trusts.

[] Pooled income funds.

[] All other Sec. 4947(a)(2) trusts treated as private foundations.

[] Any trust (e.g., a complex trust) that claims a charitable income tax deduction under Sec. 642(c) for the tax year.

Exceptions to Filing Requirement

A trust is not required to file Form 1041-A for any tax year in which the trustee is required (by the terms of the governing instrument and applicable local law) to distribute currently all of the income of the trust. For this purpose, trust income is determined under Sec. 643(b) and Regs. Secs. 1.643(b)-1 and-2 (Regs. Sec. 1.6034-1 (b) (1)).

Observation: This exception should apply to a "net income only" charitable remainder unitrust and a "net income only with make-up provision" charitable remainder unitrust (see Sec. 664(d) (3)) when such trusts' income for the tax year is less than the specified unitrust percentage. Similarly, a complex trust required to distribute all of its income annually (but allowed to make contributions of trust corpus to charitable organizations) should not have to file Form 1041-A.

For tax years beginning after Dec. 31, 1980, a trust described in Sec. 4947(a) (1) (i.e., a trust not exempt from taxation under Sec. 501 (a) and all of the unexpired interests in which are devoted to one or more charitable purposes) also is not required to file Form 1041-A (Sec. 6034(b) and Regs. (2)).

Penalties for Failure to File

A trust required to file Form 1041-A may be assessed a $10 penalty for each day it fails to file the return, up to a maximum penalty for any one return of $5,000 (i.e., 500 days of failing to file) (Sec. 6652 (c) (2) (A)).

The IRS is authorized to notify a trustee of his (or its) failure to file Form 1041-A and request that the trustee file the delinquent return (s) within 90 days after the date the notice is mailed (or some other "reasonable" date established by the Service). If the trustee fails to file the Form(s) 1041-A on or before such date, he (or it) may also be subject to a penalty of $10 per day (limited to $5,000 for any one return) (Sec. 6652(c) (2) (B) and Regs. Sec. 301.6652-2(b)).

Observation: No penalty will be imposed for failure to file Form 1041A if such failure is due to reasonable cause (Sec. 6652(c) (3)). An affirmative showing of reasonable cause must be made in the form of a written statement setting forth all the facts alleged as reasonable cause for failure to file and containing a declaration by the trustee that the statement is made under penalties of perjury (Regs. Sec. 301.6652-2(f)).

Reasonable cause is generally defined as any cause that arises despite the exercise of ordinary business care and prudence (see, e.g., Regs. Secs. 301.6651-1 (c) (3) and 301.6695-1 (b) (5), and Boyle, 469 US 241 (1985)). In making a determination as to whether there is reasonable cause, the IRS will look at the following issues:

[] Do the taxpayer's reasons address the penalty that was assessed?

[] Does the length of time between the event cited as a reason and the due date for the required activity negate the event's effect?

[] Does the continued operation of business after the event that caused the taxpayer's noncompliance negate the event's effect?

[] Should the event that caused the taxpayer's noncompliance have reasonably been anticipated?

[] Was the penalty the result of carelessness or forgetfulness, or did the taxpayer appear to have made an honest mistake?

[] Is a nonliable individual being blamed for the taxpayer's noncompliance? If so, what is the relationship between the taxpayer and the individual?

[] Has the taxpayer documented all pertinent facts?

[] Does the taxpayer have a history of being assessed the same penalty?

[] Could the taxpayer have requested an extension or filed an amended return?

[] Has the taxpayer provided sufficient detail to determine whether he exercised ordinary business care and prudence? See IRM 4562.2: (2) (7/27/92) and Consolidated Penalty Handbook IRM (20)333 (7/27/92).

To qualify for a waiver, the events constituting reasonable cause must be directly connected to the taxpayer's failure to comply and must continue throughout the delinquency period. If either is lacking, the penalty applies, at least with respect to that period The longer the delay, the more likely it is that the Service will impose a penalty. See, e.g., Crocker, 92 TC 899 (1989); Stevens Bros. Foundation, Inc., 39 TC 93 (1962); Est. of Curie, 4 TC 1175 (1945).

Ignorance of the law, in and of itself, does not constitute reasonable cause. Ordinary business care and prudence requires taxpayers to be aware of their tax obligations (Est. of Lammerts, 456 F2d 681 (2d Cir. 1972); IRM 4562.2:(4) (2/25/87)). Similarly, a taxpayer's mistake, forgetfulness or carelessness does not constitute ordinary business care and prudence and is not a basis for reasonable cause (Logan Lumber Co., 365 F2d 846 (5th Cir. 1966)).

Reasonable cause can be established, however, if the taxpayer relied on the advice of a "competent tax adviser" (i.e., tax attorney, CPA or enrolled agent) with respect to a question of substantive law. The taxpayer must have received incorrect advice after contacting a tax adviser (who is competent on the specific tax matter) and providing him with necessary and relevant information. In addition, the taxpayer must have exercised ordinary business care and prudence in determining whether to obtain additional advice based on his own information and knowledge (Boyle, supra; Consolidated Penalty Handbook, IRM (20)333.6 (7/27/92)).

What to Do When a Client Fails to File Form(s) 1041-A

If a client has failed to file Form(s) 1041-A,he (grit) should generally file the delinquent return(s) as soon as possible and request a waiver of any failure to file penalty (based on the Sec. 6652 (c) (3) reasonable cause exception). Although ignorance of the law, forgetfulness, mistake, etc., generally do not constitute reasonable cause, the IRS has applied the Sec. 6652 (c) (3) reasonable cause exception liberally.

FROM MARK T. WATSON, CPA, MS, WASHINGTON, D.C.