One of the most common questions we hear about the administration of trusts is, “Are trust funds taxed?” Like so many other financial matters, the answer is, it depends. Many people get confused that the taxable income of trusts and trust income are not the same things.
Typically, a beneficiary (and sometimes a trust itself) is subject to income tax. Income distributions are also subject to income tax, and the trust must pay the tax on any income that’s not distributed. The tax specialists at Gurian CPA can help you make sense of trust fund taxation rules and determine how to structure distributions to achieve the best results.
What are Trust Funds?
A trust fund can be a complicated concept, but once you understand the basics, you’ll feel more confident about the tax implications.
There are various types of trust funds, but the most common are revocable, irrevocable, and asset-protection trusts. Others include blind, unit, and common trust funds.
These estate planning tools are legal entities that hold property or assets for an individual or an organization and distribute them to the beneficiaries named in the trust. Terms associated with trust include:
- The grantor or the individual who places the assets in the trust fund.
- The beneficiary(ies) who receive assets from the trust.
- The trustee who manages the assets. This can be an individual or a corporation.
A primary reason for establishing a trust fund is to control who receives your assets, either during your lifetime or at your death. For instance, you might want to help a family member with the purchase of a first home or provide for a disabled loved one’s care.
Trust funds offer financial protection, tax benefits, and sometimes long-term support. Still, they also frequently have complex legal and financial structures.
Are Trust Funds Taxed?
When a trust has more than $600 of income in a given year, the trustee must file a 1041 income tax form. Unlike Form 1040, which is for personal federal income tax, a 1041 allows the trust to deduct distributions of income to beneficiaries. This ensures that either the beneficiary or the trust pays income tax, not both.
If distributions were made during the year, the trustee must file a K-1 trust distribution form which the IRS then delivers to the beneficiary, who pays the tax. In other words, the beneficiary includes the distribution as part of their income for the year.
Because the laws that govern trust funds, including how they are taxed, are continually changing, consulting with a CPA skilled in reviewing trust documents and preparing trust income tax returns can be in your best financial interests.
When you hire a qualified tax accountant to handle your trust fund income or distributions, you’ll get to spend far less time worrying about the ins and outs of trust fund taxation. Doing so can also help you avoid any penalties for an incorrect filing and reduce the risk of being audited.
If you’re looking for financial assistance or advice on a trust fund, contact Gurian CPA to request a meeting. We’re a Dallas and Houston-based CPA firm that also provides tax, accounting, business advisory services, and more to a broad range of industries.
