A Living Trust is typically a Revocable Trust, meaning the Grantor may remove Trust assets at any time. These types of Trust are often used as Estate Planning tools because they can help the Grantor avoid having his or her assets got through the Probate process upon the Grantor’s death. However, Living Trust taxes are often a source of questions from those interested in setting up a Living Trust. Many people want to know the tax implications of a Trust before they move forward with setting one up. This article offers a brief overview of the Revocable Trust tax implications, how a Living Trust is taxed, as well as will answers common questions about Living Trust taxes.
Living Truts Tax During Grantor’s Life
The individual who creates and funds the Living Trust is referred to as the Grantor. When the Living Trust is set up as a Revocable Trust, which is the most common arrangement, the Grantor can move assets in and out of the Trust or even terminate the Trust if so desired. Therefore, the Grantor remains entitled to receive the income and the principal of the Trust. As a result, the IRS still taxes the Grantor on the Trust income. Because the Trust can utilize the Grantor’s social security number to establish investments and bank accounts, all of the income related to the Trust can be reported on the Grantor’s tax return. No separate tax return will be necessary for a Revocable Living Trust. However, even though the Grantor is taxed on the Trust income, the assets are legally held by the Trust, which will survive the Grantor’s death. That is why the assets in the Trust do not need to go through the probate process.
Special Circumstances During Grantor’s Life
If the Grantor of the trust becomes mentally incapacitated, the successor trustee designated in the Trust documents may choose to obtain a separate tax ID number for the Trust. This number is called an Employer Identification Number, or an “EIN.” A successor Trust may choose to obtain an EIN for the Trust in order to limit the successor trustee’s liability for the Trust’s income tax or to assist in fulfilling the fiduciary duties the successor trustee is charged with. If an EIN is requested, a separate tax return for the trust will be required each year. The trust’s taxes, in that case, would be filed on a Form 1041 and would be filed by the same date as personal taxes.
Even if the Grantor is not incapacitated, the Grantor may choose to establish an EIN for the Trust especially where the Grantor has complex personal taxes and would prefer to not report the income and losses of the Trust on the Grantor’s tax return. The Grantor would still pay taxes on the income of the Trust but would do so through the Trust’s own tax return filed under the Trust’s EIN number.
Living Trust Tax After Grantor’s Death
After the Grantor’s death, the Trust remains in place and continues to hold legal ownership of all the Trust assets. The Revocable Trust tax implications, following the death of the Grantor, impact both the Grantor’s Estate and the Beneficiaries’. The Grantor’s final tax return is filed by the Trustee or Executor of the Grantor’s Estate, and it declares all the income earned by the Grantor through the Grantor’s death. However, any income earned by the Trust assets or principal after the date of the Grantor’s death is reported in a separate tax return for the Trust. The requirement that the Trust file its own tax return is a result of the status of the Trust changing from a Revocable Trust during the Grantor’s life to an Irrevocable Trust upon the Grantor’s death. As a result, the Trust must file its own tax return each year.
The beneficiaries of the Trust may also be entitled to distributions from the Trust, which are typically deducted from the income of the Trust on the Trust’s tax return. Depending on the type of distribution, the amount of the distribution, and other factors, the beneficiaries may have to claim income from the distribution on their own tax returns. If the distribution represents a non-income portion of the Trust principal, it is likely no taxes will be owned.
Beneficiaries should receive a report each year from the individual or entity responsible for managing the report. The report will indicate what if any income from the Trust needs to be reported by the Beneficiaries on their own tax returns. If Beneficiaries receive reports of Trust income after their own tax returns have already been filed, they will need to file an amended return, known as a Form 1040X. If the Beneficiaries have not received distributions, then the Trust pays the taxes on the Trust’s income, and the beneficiaries have no need to include the Trust’s income on their return.
Living Trusts are an excellent way to help the Grantor’s heirs avoid the complex and expensive process of Probate. Trust can be used to transfer ownership of many types of property, including Real Estate and financial assets, like bank accounts and brokerage accounts. However, the tax implications of a Trust should be discussed with an experienced Estate Planning attorney to ensure the Trust is structured in the way that is best suited for the Grantor. Additionally, an Estate Planning attorney can assist Beneficiaries with questions related to the Trust after the death of the Grantor, including answering the common question, “How is a Living Trust taxed after the death of the Grantor?” By utilizing an established Estate Planning attorney from the beginning of the process, the attorney can ensure the Trust itself is tailored to fit the needs of a particular Grantor’s beneficiaries.