How are Trusts Taxed: Basics of Trust Taxation and How to Avoid Paying Tax

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When constructing your Estate Plan, you may have questions. The Law Office of Paul Balck can explain how trusts are taxed, etc. Call us for more info.

Author: Paul Black

Paul’s experience as the son of two parents with big health challenges is what led him to the work he does today and gives him first-hand knowledge of the challenges that many caregivers and family members face. After graduation from GSU Law, Paul was chosen from dozens of applicants nationwide as one of three 2010-2011 Borchard Foundation Law & Aging Fellows. Paul has been named as  a SuperLawyers “Rising Star” in the area of Estate Planning and as a member of Georgia’s “Legal Elite” by Georgia Trend magazine. Published on: October 03, 2022. 

How are Trusts Taxed

How are Trusts Taxed section

It’s never too early to start planning for your family’s future.

If you have questions, I’m here to help. There is no commitment and we provide free initial 15-minute phone calls. We look forward to meeting you.

It’s never too early to start planning for your family’s future.

If you have questions, I’m here to help. There is no commitment, and we provide free initial 15-minute phone calls. We look forward to meeting you.

There are several types of trusts, each of which is taxed differently. A trust is a distinct legal and taxable entity. Whether a trust is a simple, complex, or grantor trust determines whether the trust is responsible for its taxes as a separate tax entity. Both simple and sophisticated trusts must pay their income taxes.

Grantor trusts do not pay their taxes; instead, the trust’s grantor is responsible for paying the taxes on the trust’s income. A trust can give you control over the trust beneficiary and how they can get it, and why.

Working with a revocable trust lawyer ensures that your trust funds are properly structured to carry out your specific intentions. They will advise you on ways to protect your taxable income with a trust agreement and familiarize you with the legal entity that exists in your state.

Trusts can give you and your family many financial benefits and protect assets that you own. An estate planning attorney is essential to create a lasting legacy for those you love the most and for other estate tax purposes, provided that you have a legitimate trust document. Call Paul Black at (404) 347-8727 or contact us online to answer your questions about your estate plan.


What Rate Are Trusts Taxed at?

Trusts get taxed at 37% of all the trust income that exceeds $12,750. Today, most trusts are created as grantor trusts for federal income tax purposes. For a grantor tax, the trust does not pay any taxes. The trust income flows through the settler’s personal income tax return. There are different types of grantor trusts, but the most common are revocable and irrevocable trusts.

The revocable grantor trust owners do not want their trust beneficiary to go through the court process after they pass on. Hence, they set up the grantor trust to avoid probate. This means that the trust does not have to pay income tax, as the grantor still holds the estate.

If your revocable living trust owns some rental property, an investment account, rental income, or investment income, the grantor will continue paying their tax. For irrevocable trust assets, the person who sets up the trust reports that income on their income tax return. For instance, a couple who file jointly can have up to $612 in a year without getting to the 37% income tax rate.

How Do Trusts Avoid Taxes?

Trusts get to pay taxes, but they may not pay all types of taxes. Some countries will automatically exempt the trust from a gift tax. The beneficiary may be required to pay estate or other kinds of taxes on assets such as property.

You should note that all first-party trusts fall under grantors’ trust for income tax purposes. Although identifying who the grantor is in the case of income tax purposes is challenging at times, the grantor is considered the person who sourced funds to the trust.

The trust pays taxes if it’s an irrevocable trust. If it’s revocable, it’s called a grantor trust which means that the same person who sets it up manages the grantor assets. The same person is the trust beneficiary. In this case, the internal revenue service calls it a disregarded entity.

If you use your Social Security number, the internal revenue service will not know that the trust assets exist, and you will file your 1041 just like you always did and claim all the income within the trust. Your trust should have a provision in which all the assets are paid out. At least quarterly annually or at least annually, your trustee will be required to report all the income and assets.

The trust asset should be in an account that can be moved around and removed from the income tax rolls. Reach out to us to find out more.

Do Beneficiaries Pay Taxes on Trust Distributions?

Usually, beneficiaries of trusts pay taxes on the income distributions they get from the trust rather than the trust itself. These beneficiaries are exempt from paying taxes on distributions made from the trust’s principal.

Nevertheless, the trust beneficiaries are required to pay taxes on the items included in their income. The beneficiaries must also file income tax returns based on the distributions they receive from the trust.

Trust Income Distribution and its Impact on Trust’s Tax Liability

In terms of taxation, trusts can be categorized broadly into simple and complex trusts. A complex trust is one that retains some or all of its income or has a right to distribute its principal, while a simple trust mandates all income be distributed annually. The Internal Revenue Code specifies unique rules for how trust income distributions are taxed.

Generally, when a trust distributes its income, the tax liability associated with that income shifts from the trust to the beneficiaries. These beneficiaries are then responsible for reporting the income on their individual tax returns. The trust itself is allowed to deduct any distributed income from its taxable income, which can significantly lower the trust’s overall tax liability. This setup is often beneficial as trusts typically reach the highest tax brackets at much lower income levels compared to individual taxpayers.

Trust Qualification for Estate Tax Exemption

In regards to the estate tax exemption, a trust in and of itself cannot qualify for this exemption. Instead, the estate tax exemption applies to the estate of the deceased person, not to the trust. As of my knowledge cutoff in 2021, the estate tax exemption is $11.7 million for individuals and $23.4 million for married couples. Any estate value exceeding this amount is subject to federal estate tax.

However, certain types of trusts, such as bypass or credit shelter trusts, can be structured to take full advantage of the estate tax exemption. These trusts are often established by a will upon the death of the first spouse.

They contain an amount up to the estate tax exemption, with any remaining assets usually going into a marital trust for the benefit of the surviving spouse. The bypass trust is not subject to estate taxes upon the second spouse’s death, effectively preserving the exemption.

What Is the Difference Between a Revocable Trust and an Irrevocable Trust?

Many people choose to use trusts in their will, but the big question is whether it’s revocable or irrevocable.

There are several financial advantages to irrevocable trusts over revocable trusts, which is why irrevocable trusts are more popular among individuals and businesses. An irrevocable trust can be regarded as a complex, simple, or grantor trust according to the powers in the trust instrument. Insurance trusts can be categorized as irrevocable because they have life insurance assets that allow the grantor to exempt assets from estate tax.

A revocable grantor trust intends that the trustee can redistribute money or property that has been placed in the trust as long as the trustee gets permission from the settler. Also, it is essential to note that even if a revocable grantor trust has been declared invalid, any assets belonging to its beneficiaries are still considered their property.

What Are Testamentary and Inter Vivos Trusts?

A will creates testamentary trusts. In other words, the trust was created by someone who has already died. Testamentary trusts do not require court probate and are usually overseen by a trustee who goes through the deceased’s will to obtain money from the estate. Testamentary trusts are often called “will trusts.”

An inter vivos trust is created during someone’s lifetime and formed for their benefit. This trust is created during the settlor’s life using their earned income. It’s set up to help beneficiaries in the future. For example, a husband may set up an inter vivos trust for his wife so that she can continue living in their home even after he dies. A probate lawyer can help you set up your own inter vivos trust.

Contact a Trust Attorney Today

If you have tax issues or want to make trust claims, having an experienced attorney will help you deal with the confusion. The Law Office of Paul Black has a team of revocable lawyers who will ensure that your grantor and non-grantor trust assets are secure.

In addition, they will provide you with a free initial consultation and will give you the information needed to make an informed decision about the trust that best suits your needs. Call us at (404) 347-8727 or contact us online to answer your questions about your estate plan or any other assets you own.

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