Trust Taxation
The tax rules governing income earned by a trust, which can be subject to taxation at the trust level or passed through to beneficiaries. The tax treatment of a trust depends on its classification, structure, and jurisdiction.
Revocable Trusts (Grantor Trusts)
The trust’s income is taxed to the grantor (the person who created the trust).
Assets in the trust are still considered part of the grantor’s estate for estate tax purposes.
Irrevocable Trusts
The trust itself is a separate tax entity and must file its own tax return (Form 1041 in the U.S.).
Income can either be taxed at the trust level or distributed to beneficiaries and taxed at their individual rates.
Simple Trusts
Required to distribute all income to beneficiaries annually.
The trust itself does not pay tax on income that is distributed—beneficiaries pay tax on it.
Complex Trusts
Can accumulate income, distribute principal, and make charitable contributions.
If income is retained, it is taxed at the trust level, often at higher rates than individual tax rates.
Grantor Trusts
The grantor is responsible for paying income taxes on trust income, even if they do not receive the income.
Used often for estate planning and asset protection.
Key Tax Considerations
Trust Tax Rates: Trusts often reach the highest tax brackets much faster than individuals.
Distributable Net Income (DNI): Determines how much income is passed to beneficiaries for tax purposes.
Capital Gains: Typically taxed at the trust level unless distributed to beneficiaries.
State Taxation: Varies by state; some states tax trusts based on where they were created or where the trustee resides.
Estate and Gift Tax Implications: Certain trusts can help minimize estate taxes or transfer wealth tax-efficiently.