Dealing with trusts and the tax implications for those who create them, and their beneficiaries can seem confusing. Nevertheless, with the help of an experienced estate planning attorney, those issues can be managed, according to a recent article, “5 Taxes You Might Owe If You Have a Trust,” from Yahoo! Finance.
Trusts are legal entities used for various estate planning and financial purposes. There are three key roles: the grantor, or the person establishing the trust; the trustee, who manages the trust assets; and the beneficiary, the person or persons who receive assets from the trust.
Trusts work by transferring ownership of assets from the grantor to the trust. By separating the legal ownership, specific instructions in the trust documents can be created regarding using and distributing the assets. The trustee’s job is to manage and administer the trust according to the grantor’s wishes, as written in the trust document.
Trusts offer control, privacy, and tax benefits, so they are widely used in estate planning.
There are two primary types of trusts: revocable and irrevocable. Revocable trusts are adjustable trusts that allow the grantor to make changes or even cancel during their lifetime. They avoid the probate process, which can be time-consuming and expensive, especially if assets are owned in different states. However, the revocable trust doesn’t offer as many tax benefits as the irrevocable trust.
Think of irrevocable trusts as a “locked box.” Once assets are placed in the trust, the trust can’t be changed or ended without the beneficiary’s consent. In some states, irrevocable trusts can be “decanted” or moved into another irrevocable trust, requiring the help of an experienced estate planning attorney. However, irrevocable trusts are not treated as part of the grantor’s taxable estate, making them an ideal strategy for reducing tax liabilities and shielding assets from creditors.
Trust distributions are the assets or income passed from the trust to beneficiaries. They can be in the form of cash, stocks, real estate, or other assets. For instance, if a trust owns a rental property, the monthly rental property generated by the property could be distributed to the trust’s beneficiaries.
Do beneficiaries pay taxes on distributions from the principal of the trust? Not generally. If you receive a distribution from the trust principal, it is not usually considered taxable. However, the trust itself may owe taxes on any income it generates, including interest, dividends, or rental income. The trust typically pays these before distributions are made to beneficiaries.
It gets a little complicated when beneficiaries receive distributions of trust income. In many cases, the income is taxable to the beneficiaries at their own individual tax rates. This can create a sizable tax wallop if you are in your peak earnings years.
There are ways to plan to minimize the tax consequences strategically. One approach is to structure trust distribution with a Charitable Remainder Trust, where income goes to a charity for a set number of years, and the remaining assets are then distributed to beneficiaries. An estate planning attorney will be a valuable resource, so grantors can achieve their goals and beneficiaries aren’t subject to overly burdensome taxes.
To learn more about estate planning in the East Valley, Gilbert, Mesa and Queen Creek, schedule your free consultation with Attorney Jake Carlson by using one of the links above.
Reference: Yahoo! Finance (Sep. 27, 2023) “5 Taxes You Might Owe If You Have a Trust”