A trust is an arrangement that allows a third party known as a trustee to hold assets for a beneficiary. Trusts may be used as part of your estate planning, or you might form a trust to assist with controlling money for your heirs.
Trusts can also help you prepare a strategy for financial management if you anticipate not being able to make decisions in the future; by setting up a trust now, you can specify how you want the money used or dispersed while you’re still capable of doing so.
There are several types of trusts with distinct benefits. The procedure for calculating taxes on a trust depends on what type of trust you have.
The Primary Types of Trusts
There are two broad categories for trusts: revocable trusts (also known as living trusts) and irrevocable trusts.
A revocable trust can be changed by the originator or creator of the trust for any reason and at any time. The creator of the trust retains ownership over the assets, and they don’t have to seek permission or approval to change the trust’s guidelines.
Irrevocable trusts may not be changed, even by the creator, once the trust is established. Funds in an irrevocable trust may only be used for the benefit of the trust’s beneficiary (unless the trust’s terms state otherwise).
Taxation for Trusts
Revocable trusts are fairly simple when it comes to paying taxes on the trust’s income. Any income generated by the trust is taxable to the creator for as long as they’re alive.
The reasoning behind this guideline is that the creator retains full ownership and control over the assets in the trust; any taxation events will be reported under the creator’s Social Security number, making them responsible for the trust’s taxes. No tax return is filed for the trust; everything is filed under the creator’s name.
Usually, irrevocable trusts have their own tax identification numbers. This makes the IRS and other taxation authorities aware of its existence. An irrevocable trust can be taxed as a grantor or non-grantor trust.
For a grantor trust, all trust income is reported on the creator’s income tax return. An irrevocable trust funded with the creator’s assets is usually viewed as a grantor trust.
When dealing with a non-grantor trust, any income that isn’t distributed to or used for the benefit of the beneficiary is taxed to the trust using the trust’s tax identification number. However, if income is used to benefit the beneficiary or dispersed to the beneficiary, then the income is reported on the beneficiary’s tax return.
How the trust is taxed will impact its overall taxation rate. Generally, trusts are taxed at higher tax rates than individuals. We can formulate a plan to help you minimize your tax obligation while ensuring that your trust is right for your financial planning and specific needs.
Learn More About Trusts and Taxation
Have additional questions about paying taxes on a trust or want to explore options for reducing your tax liability? Contact Gurian CPA Firm to schedule an appointment.
