Taxation on trusts is dependent on numerous factors, including the size and value of the trust, and the way it is structured.
THE BIG PICTURE:
Taxation on a trust is generally dependent on whether or not they are considered a grantor trust, and the income they generate if they are a non-grantor trust.
- Grantor trusts are not recognized as an entity by the IRS – all tax characteristics are instead passed on from the trust to the Grantor.
- Non-Grantor trusts are taxed as an entity, and are required to obtain an EIN from the IRS in order to file returns and maintain bank accounts.
- Taxation rates are far more advantageous for Grantor trusts, as they are taxed at individual rates rather than entity rates.
Trusts do not pay taxes on distributed income – the receiver of the distribution is responsible for the taxes on that income instead.
- It is important, then, to ensure that the Grantor’s trust document makes active distributions to lower the trust’s tax burden, as it will only pay taxes on the retained income.
- Non-Grantor trusts start paying the highest federal income tax rate for income above $12,950.00.
COMPARE AND CONTRAST:
Estates are taxed very similarly to Non-Grantor trusts, including having to pay income tax on retained income.
- For this reason, estates should be administered quickly, in order to distribute as much of the estate’s income as possible.
- Estates have the ability to apply for a lengthened or shortened tax year if the administration process runs longer or shorter than expected, within reason.
- Estates with a total value over $11.58 million are subject to an additional estate tax.
Specialized trusts can occasionally receive a different type of tax treatment under certain circumstances.
Intentionally Defective Grantor Trusts straddle the line between Grantor and Non-Grantor trusts, in that they are considered a separate entity for estate tax purposes, but a Grantor trust for income tax purposes.