Trust funds can be a great way to provide ongoing support or to pass on wealth to spouses, family members, or charities while offering significant tax advantages to both the creator of the trust and the beneficiary. Many trusts can also avoid probate in the event of the creator’s death. But are trust funds taxable? Yes, they are, and here are the basic concepts you need to know about taxation when considering a trust:
Grantor, Trustee & Beneficiary
The person that creates the trust is called the grantor, and the person or entity that receives money from the trust is called the beneficiary. A trustee manages the trust on the behalf of the grantor, and distributes the money from the trust to the beneficiary. Not all trusts have trustees, leaving the responsibility of management to the grantor.
Revocable Vs. Irrevocable Trusts
The terms of a revocable trust can be altered or the trust can be closed during the lifetime of the grantor. An irrevocable trust, or those that become irrevocable at the death of the grantor, cannot be changed or closed, which effectively transfers all assets of the trust to the beneficiary, according to the existing distribution schedule.
How Are Trust Funds Taxed?
There are two types of distributions that are taxed when it comes to a trust: principal and interest. The principal is the amount of money initially placed into the trust, and the interest is the money accumulated on the principal via interest.
All taxes on the principal are paid by the grantor or the trust, as well as any taxes on interest income that it does not distribute by the end of the tax year. Beneficiaries are responsible for paying taxes on interest income that has been distributed, but they do not pay taxes on any principle that has been distributed, as those taxes are paid by the grantor or trust. In an irrevocable trust, where the trust has control over distribution amounts and income earnings, the trust must pay a trust tax of $3,011 plus 37% of any earnings over $12,500.
When the grantor or trust distributes money, it is taken first from the interest income, then from the principal. The trust will issue a form K-1 each year that indicates how much of the year’s distributions are from interest and how much is from the principal, and a form 1041 will be filed by the trust to determine the income distribution deduction that applies.
Tax Advantages of a Trust Fund
In a grantor trust, where the grantor controls distribution, the income of the trust is taxed like personal income, often at a lower rate than that of a non-grantor trust. In a non-grantor trust, a third-party trustee is responsible for distributions, reporting income, and paying taxes on the trust. In this case, the trust itself becomes a taxable entity, and the trust’s income can be taxed at a higher rate of up to 37%. Grantor trusts can provide significant tax advantages for the grantor.
Beneficiaries benefit from the trust by paying taxes only on the interest income, plus they can avoid probate in the event of the grantor’s death.
Choose Gurian CPA for Help With Trust Fund Taxes
Are trust funds taxable? How are earnings distributed? If you have questions about creating or managing a trust for your loved ones or your favorite charity, contact our team at Gurian CPA. Our professional accountants can help with trust fund tax issues, estate taxes, business taxes, and more. We are a full-service accounting firm based in Dallas, Texas, and we are here to help with all your financial needs.
Give Gurian CPA a call today at (469) 306-9866 or contact us online to request a meeting with our experienced accounting professionals today.
