Depending on how trust documents are drafted, trust income can be taxable to beneficiaries, to you, to the trust, or to a combination of all three. Maybe you want to pay the tax so your beneficiaries don't have to. Maybe you prefer that the trust pay them separately. When creating your trust, you have the flexibility to draft it with your preferred tax consequences in mind.
Retaining Control Can Cost You
If you create a revocable trust and maintain some control over it, you are responsible for paying the tax on any income the trust earns. For example, if you put a stock portfolio that pays dividends into your trust, you are responsible for reporting the dividends on your tax return. If you don't retain any authority or control over the trust, the trust reports the dividends on a separate tax return.
Your Beneficiaries May Have to Pay Income Tax
You can create the trust in such a way that all income must be paid to the beneficiaries rather than remain within the trust. For example, if you place a rental home into the trust, your lawyer can draft the trust document so that all rental income is paid out to your beneficiaries each month. In this case, the beneficiaries must report all rental income on their personal tax returns.
Pay Income Taxes Directly from the Trust
The trust, rather than you or the beneficiaries, can pay the tax on all earnings from trust property. When the trust document doesn't require income to be distributed to beneficiaries and you don't retain any interest in the trust, the trust is responsible for the income tax. When the trust pays the income taxes, beneficiaries will not have to pay tax again on that same income when it's distributed to them.
Trustees Must File Tax Returns
A trustee manages the trust and the property it holds. Trustees also have administrative duties, one of which is filing annual trust income tax returns. Trust tax returns must be filed for any year the trust earns $600 or more of taxable income. In the event your trustee doesn't fulfill these tax filing obligations or operates the trust for personal gain rather than in the best interest of the beneficiaries, you may have a legal claim to recoup any losses.
A Trusts and Estates Lawyer Can Help
The law surrounding trusts and taxes is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a trusts and estates lawyer.