Taxpayers may establish trust funds to pursue several goals, including orderly distribution of assets, tax management, and a desire to provide income to beneficiaries. Often, tax management is a priority. Keep in mind that federal estate taxes only apply when an estate's value exceeds $12.06 million. Very few estates meet that threshold. However, the tax rate imposed on amounts over the threshold is forty percent, which can take a hefty bite out of an inheritance.
Besides the federal levy, seventeen states (and the District of Columbia) have estate taxes, with much lower threshold amounts but also with lower tax rates. While a federal or state estate tax is imposed on the estate itself, an actual inheritance tax is applied to the amount a beneficiary receives. Six states have an inheritance tax, although no federal one exists. States with estate and inheritance taxes typically allow exceptions for certain close family members.
How can a trust fund help?
Trust funds are accounts that a trustor (grantor) creates for the benefit of someone else or something else since trusts may have other entities as recipients. The trustor transfers assets into the trust, which is then managed by a neutral third party, the trustee. The trustee also distributes assets or income from the trust to the beneficiaries per the grantor’s instructions. Trust creators may include various assets, including cash, stocks, bonds, land, and business interests.
The assets that comprise the trust fund have already been taxed so any principal distribution would be untaxed. However, distributions typically come from trust earnings, which would be taxable to the beneficiary. Those distributions are deductible for the trust.
Does the type of trust matter?
Revocable trusts are always grantor trusts. Usually, these become irrevocable when the grantor dies. Grantor trusts allow the trustor to maintain control and change or revoke the trust while living. The IRS considers the assets of a grantor trust to be those of the grantor, subject to the same tax rate as the grantor.
The trustor can't change irrevocable trusts without the beneficiaries' agreement. Trusts are also defined as simple or complex. According to the IRS, simple trusts are not grantor trusts and must distribute all income annually to the beneficiaries per the trust’s terms. Simple trusts do not distribute principal or make gifts to charities.
Testamentary trusts are always irrevocable because they are created in a will and become effective when the trust grantor dies.
Charitable remainder trusts have unique tax benefits, along with specific distribution rules. A CRT can distribute income to both the trustor and their beneficiaries. These trusts distribute income for a particular period of time, which the trustor determines but is limited to either twenty years or the trustor's lifetime. The income can go to the trustor and non-charitable beneficiary during the term, and then the remainder is distributed to the charitable beneficiary at the end. The trust is tax-exempt, but the non-charitable beneficiary pays taxes on distributions they receive.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
