Tax day is only a week away, and preneed trust returns will look a little different this year.  As we reported back in December, the IRS took the position that preneed trusts are subject to the Medicare Tax used to fund the Affordable Health Care Act.  Accordingly, Federal Form 1041QFT now requires the reporting of “Net Investment Income” or “NII”.   The NII threshold for the Medicare Tax is $11,950, and most preneed trusts will need to file a composite return to avoid this 3.8% tax.

The composite return requires an individual account to report each character of income and expense, and now a column for “net investment income” or “NII”.   The NII column is also helpful to distinguish an individual account’s gross net income from net taxable income.  With the position taken by the IRS to impose the Medicare Tax on the QFT, preneed administrators can be more confident in applying the Schedule D tax rates on an individual account basis.  For trusts diversified into equities that produce long term capital gains and qualified dividends, the difference between NII and net taxable income could be substantial.

If an individual account’s NII is $2450 or less, long term gains and qualified dividends would not be taxable.  If these two types of income account for half of the trust’s income, the trust’s tax liability is reduced by half.  With a NII threshold of $2450 for the Schedule D rates, most preneed contracts will not be taxable on qualified dividends or long term capital gains.  The challenge for administrators may be documenting that fact.  The Form 1041QFT instructions reference Part V of Schedule D.  It is not practical to prepare a Schedule D for each individual QFT account.