As most people have heard, trusts are perhaps the most useful tool in estate planning. They help manage assets during life and long after we are gone.
When you place assets in a trust, the trust gets legal title to the assets. But, who pays income tax on interest, dividends, gains and other income generated from the assets when they are in the trust? This depends on the type of trust.
For income tax purposes, there are generally two types of trusts, “grantor” trusts and “non-grantor” trusts. With a grantor trust, all of the income and deductions flows to the income tax return of the creator of the trust, the “grantor.” In fact, a grantor trust typically uses the social security number of the grantor as its taxpayer identification number. A revocable living trust, the most common type, is a grantor trust while the grantor is alive. Certain powers held by the creator of the trust, such as the power to revoke the trust, cause the trust to be a grantor trust. Other technical administrative powers also can cause a trust to be a grantor trust.
If a trust is a not a grantor trust, it is a non-grantor trust. With a non-grantor trust, the trust has a separate taxpayer identification number, which is like the trust’s own social security number. The trust’s income and deductions go on its own return. While an individual files a Form 1040, a non-grantor trust files a Form 1041. If such a trust makes distributions to a beneficiary, in general those distributions carry any taxable income the trust has to the beneficiary, up to the amount of the distribution. So, if the trust earns $1,000 of income and distributes $400 to a beneficiary, $400 of income is taxed to the beneficiary and the trust gets an offsetting deduction, so that $600 is taxed to the trust itself. If the trust has the same income and distributes $3,000, the full income of $1,000 is taxed to the beneficiary and nothing is taxed to the trust. The additional $2,000 is considered a distribution of principal and is not taxed to the beneficiary.
Of course, if you are a trustee, it is important to consider the income tax brackets of the beneficiaries and of the trust itself when deciding on when and to whom distributions should be made. An attorney specializing in tax and estate planning can help you plan or administer a trust in a manner that maximizes tax savings while minimizing headaches.
Morrison Law Group, PLC is devoted exclusively to estate and elder law matters. We are members of the American Academy of Estate Planning Attorneys and offer guidance and advice to our clients in every area of estate planning. The firm has been engaged in Louisiana trusts and estate law for the last 18 years. To learn more about how you can achieve your estate planning goals, please call (504) 831-2348 or visit our website at www.morrisonlawplc.com.
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