When delving into trusts, one important topic is taxes, the management of which is often a key consideration for creating them. The grantor is the individual who creates the trust, which is managed by a trustee, who is a different person or entity. The trustee should be a neutral third party who oversees the trust’s assets on behalf of the beneficiary, who is designated to receive distributions from the trust.
Trusts come in several varieties.
Any arrangement where a trustee manages assets for the beneficiary is a trust, but there are variations. For example, suppose the account is structured as a grantor trust. In that case, the grantor is responsible for the income and the accompanying taxes, even if the income goes to the beneficiaries. That would typically be due to the grantor’s preference to retain control over assets or the ability to revoke trust conditions.
These grantors need tax information from the trust.
When the grantor is the taxable entity, they need a grantor letter to use when filing their taxes. According to the IRS, a trust is a grantor trust if the grantor retains certain powers or ownership benefits relating to all or a portion of the trust. In that case, the grantor trust is irrelevant for tax purposes, and the income and deductions are treated as directly belonging to the grantor.
The fiduciary (trustee) must provide the grantor with the information they need to supply as an attachment to their Form 1041. The IRS instructions specify that the attachment must include:
- The relevant information identifying the person to whom the income is taxable;
- The details about the taxable income; and
- Any deductions or credits that apply to the income.
Grantor trusts are revocable.
Since grantors retain the ability to revoke the trust, change the beneficiary, or swap out assets, the grantor can still benefit from the trust's assets. That's why they also remain liable for the taxes due and need the grantor letter to attach to their tax return. While a revocable trust can be helpful in efficiently distributing your assets after you die, they don’t typically reduce or eliminate your tax obligation during your lifetime.
In most cases, the revocable living trust is a pass-through entity that doesn't pay taxes. Instead, the grantor pays them at their personal rate. That’s why the grantor needs the letter from the trustee to provide the detail regarding all the trust’s financial transactions for their income tax filing.
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.
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.
