In some cases, trusts can allow you to leave assets or property to a loved one without your estate having to go through probate. Although there are tax benefits associated with trusts, figuring out the consequences can be complicated. Understanding how much of a trust distribution is taxable can be challenging, but it’s an important aspect to be aware of.
Irrevocable vs. Revocable Trusts
Different types of trusts get taxed differently. The most common are revocable and irrevocable trusts.
One you place assets in an irrevocable trust, the property no longer belongs to you. An irrevocable trust is treated as a separate entity and therefore must file taxes. Your trustee is responsible for reporting all income that a trust earns, even if the terms of the trust require your beneficiaries to receive the income.
Under an irrevocable trust, the income generated by the trust is generally distributed to your beneficiary. This usually results in a tax deduction for the actual trust itself and your beneficiary is responsible for paying a tax. A more complex trust can allow for distributing trust principal or an accumulation of income. If you have a revocable trust, the assets in the trust are part of your estate and you include the trust’s income on your tax returns.
Irrevocable trusts can take deductions to reduce taxable income because income generated by this kind of trust results in a potential tax liability for the trust. Your beneficiary does pay income tax when getting a distribution. Even if taxation for trusts seems confusing, most trusts are designed to make the distribution process simple.
Understanding What Works Best for You
In contrast to a will, in which the proceeds are distributed to your heir all at once, a trust can specify that distributions be made only at specified intervals or upon the achievement of certain milestones. A TuckerAllen estate planning attorney can help tailor a plan that works best for your situation and goals.