A frequent question we receive is will having a trust affect my taxes? Specifically, do I need to file another, new return and do I pay more taxes? To answer this question, you must determine if your trust is revocable or irrevocable.
Revocable Grantor Trusts and Taxes
At Grissom law, we typically draft our revocable trusts so that they are Grantor trusts, which means that the trust is a disregarded entity for tax purposes. When the time comes to file your tax return, your CPA files as they normally would, using your social security number. Because you have the right to all income and principal from your trust, and you can modify or terminate your trust, all assets are treated as yours. No separate tax return is required and all income generated by trusts assets is taxed at your individual rate. If your trust was taxed as a separate entity, the tax rate would be much higher and your tax bill would be greater.
Like any asset in your name, any gain on the asset will also be attributed to you, and you must report and file the gain as capital gains on your tax return.
Revocable Trust with a Separate TIN and Taxes
Alternatively, some people choose to obtain a separate TIN (Tax Identification Number) for their trust even while they are living. By choosing to have a separate number, accounts will be tied to the new TIN and not your social security number, which means when you pass, the accounts may remain unchanged and not require a new TIN. While you are living, you can still attribute the income to your tax return by generating either a 1041 or a 1099. This option does require separate filings, collecting the appropriate tax documents for each account, and making sure income and principal are allocated appropriately so you don’t end up paying more in taxes than is necessary. Working closely with a CPA will be necessary if you have a separate TIN with your trust but this option does allow more privacy and flexibility.
Irrevocable Trusts and Taxes
An irrevocable trust, generally, requires a separate TIN and cannot use your social security number. Typically, you do not want the assets attributed to you if you are trying to separate them from your personal income and assets or remove them from your taxable estate. There are exceptions, times where having the income taxed to you is still appropriate, and an estate planning attorney will assist you when this selection is appropriate.
A trust will then be either a simple trust or a complex trust.
A simple trust is one where all the income is treated as distributed to the beneficiaries. In such a case, the trust reports all income annually, but is entitled to a deduction for the entire amount distributed to beneficiaries. The result is that the trust only pays tax on capital gains.
A complex trust is one where all of the income is not distributed to the beneficiaries. A complex trust is permitted a deduction, when computing taxable income equal to the amount of income for the year that must be distributed and other amounts paid or required to be distributed for the tax year. The deduction received by the complex trust for distributions made during the year cannot exceed the trust’s DNI (distributable net income).
At Grissom Law, we work with you to find the best estate plan for your financial situation, and take into consideration all tax consequences. Balancing income tax, estate tax, gift tax, tax deferred accounts, and generational taxes can be complicated but we can make it easier for you.
Disclaimer
This Blog/Web Site is made available for educational purposes only as well as to give you general information and a general understanding of the law, not to provide legal advice. By using this blog site you understand that there is no attorney-client relationship between you and Grissom Law, LLC.