Taxes for Trusts

Trusts are great tools for many reasons.

There are mainly two types of trust, revocable & irrevocable.

When a revocable trust is funded by a grantor, the assets continue to be treated as the grantor’s own, for tax purposes.

There are three parties involved when forming a trust: the Grantor, the Trustee, and the Beneficiary(ies).

Revocable trust

Since probate is a costly and lengthy process, one of the main purposes of setting up a revocable trust is to avoid estate probate when the grantor passes away.

When a revocable trust is funded by a grantor, the assets continue to be treated as the grantor’s own for tax purposes; therefore, there is NO gift tax to file. Upon the grantor’s death, the trust assets are included in the grantor’s estate and receives a step-up basis equal to the fair market value (FMV) at death. This is a big tax benefit for beneficiaries to save taxes when they sell the inherited properties at no or low capital gain after grantor’s death.

Irrevocable trust

There are three main reasons for irrevocable trusts:

1. Minimizing the estate tax
2. Help those with disabilities and special needs, to qualify for government benefits

Asset protection

For legal purposes, there are different types of irrevocable trusts.

For tax purposes, trusts are filed as either a Simple trust, Complex trust or Grantor trust.

For a Simple trust, all the income must be distributed to the beneficiaries annually; the trust fund must not payout any of its corpus/principal and cannot make charitable contributions.

A Complex trust, (unlike a Simple trust), can distribute both income and principal assets to beneficiaries and can make charitable donations.

In general, a trust must file a tax return and a Schedule K-1 will be generated. K-1 income flows through and taxed to the beneficiaries.

Grantor trusts are considered a disregarded entity for income tax purposes. Therefore, any taxable income or deduction earned or incurred by the trust will be taxed on the grantor’s tax return.

In general, contributing assets to Irrevocable trusts requires the grantor to file a gift tax return if the gift is “complete”. In some cases, funding assets to the trust are incomplete gifts, for example, when the grantor still has a power of appointment, and then there is no need to file a gift tax return.

When preparing trust tax returns, understanding trust documents created by an attorney is important to determine the correct type of trust to file as well as to determine if the transferring assets are a complete gift or not.

By Paul Mei, CPA @ Mei CPA PC 1714 86th Street 2nd FL, Brooklyn NY 11214 T: 718-975-3363