The Trust Lawyers Blog

Taxation Of Trusts

Posted by Dave DePinto on Fri, Jun 10, 2016

1. Simple Trust: A simple trust requires all income to be distributed annually to named beneficiaries. Income of the trust is taxable to recipient.

2. Complex Trust:   A complex trust does not require all income to be distributed annually. The trust provides that income may be distributed to beneficiaries or accumulated.   Income of the trust is taxable to recipient to the extent distributions are received.

3. Grantor Trust:  A grantor trust is a trust in which all items of income, gain, loss or deduction will be reported on the grantor’s personal income tax return.

 

 

 TYPES OF TRUSTS

  1. Revocable Trust

Definition:  A revocable trust is a device where the person creating and funding the trust, known as the “Grantor,” can maintain control over the Trust assets during their lifetime, retain the right to revoke or amend the trust, provide for automatic management of assets in the event of physical or mental incapacity and potentially avoid probate at death.  The trust would become irrevocable upon the death of the Grantor and can no longer be changed once the Grantor is deceased.

Tax Treatment: Grantor Trust under IRC §676 per se. As such, ignored for federal income tax purposes during Grantor’s lifetime. No EIN for trust is necessary if Grantor is the sole Trustee or a Co-Trustee. If the Grantor is a sole Trustee or Co-Trustee, it is permissible to use the Grantor’s Social Security Number. No 1041 is required to be filed unless the trust is a joint revocable trust and married filing separately. If the Grantor is not a Trustee of the trust, then an election can be made to use the Grantor’s Social Security Number (such election is not automatic) or if election is not made, then an EIN is required. Upon the death of the Grantor, the trust becomes a complex trust. An EIN will be required upon death of the Grantor or if Grantor has multiple revocable trusts.

 

2. Testamentary Trust

Definition:  A testamentary trust is a trust which becomes effective upon the death of the testator. The terms of the testamentary trust are specified under the testator’s Last Will and Testament.

Tax Treatment: Once created, a testamentary trust is treated as a separate taxpayer and will be required to file a separate tax return. EIN is always required at such time.

 

  1. Irrevocable Trusts (Intervivos) - A TIN and Form 1041 are always required

 a. Irrevocable Life Insurance Trust

Definition:  The irrevocable life insurance trust is the owner and beneficiary of one or more life insurance policies in order to remove the insurance proceeds from the taxable estate of the Grantor upon his death. Grantor gifts to trust each year for premium costs.

Tax Treatment: Grantor utilizes annual exclusion amount under IRC §2503(b) for gifts to trust (as long as trust provides for Crummey powers for the present interest requirement). Grantor Trust under IRC §677 as to income. Grantor Trust to principal if IRC §675-4 power included.

 

b. Intentionally Defective Grantor Trust

Definition: A trust purposely created as a Grantor Trust for income tax purposes.

Tax Treatment: Grantor Trust under IRC §675 (also see Rev. Rul 2004-64, 2004-2; and Rev. Rul 2008-16).

 

c. Beneficiary Defective Grantor Trust

Definition: A beneficiary of the trust is treated as the Grantor for income tax purposes.

Tax Treatment: Grantor Trust to beneficiary under IRC §678(a).

 

d. Asset Protection Trust

Definition: A self-settled trust which provides for funds to be held on a discretionary basis for the benefit of the beneficiary to prevent attack of trust property from future creditors and predators. Not applicable in New York.

Tax Treatment: Grantor Trust under IRC §677(a)(2) as to income and IRC §675-4 as to principle and possibly IRC §674 due to Special Power of Appointment. No gift by Grantor because of Special Power of Appointment under Treas. Regs. §25.2511(2)(b).

 

e. Medicaid Trust

Definition: A self-settled trust created to shield assets from Medicaid (pursuant to Federal law).

Tax Treatment: Grantor Trust under IRC §677 and possibly IRC §675. No gift by Grantor because of Special Power of Appointment under Treas. Regs. §25.2511(2)(b).

 

f. Qualified Personal Residence Trust

Definition: Grantor gifts title to real property into a Qualified Personal Residence Trust (QPRT) and retains right to live in property for a fixed term. Upon expiration of fixed term, the property is removed from the estate of Grantor.

Tax Treatment: Gift made to QPRT requires gift tax return to be filed. During fixed term, Grantor Trust under IRC §677 as to income and IRC §673(a) as to principal. Upon expiration of fixed term, possibly a Grantor Trust depending on the terms of the QPRT.

 

g. Grantor Retained Annuity Trust

Definition: Grantor gifts assets into Grantor Retained Annuity Trust (GRAT). Grantor receives annual payment from the trust for a fixed term. Upon expiration of term, remaining trust property distributed to beneficiary of trust.

Tax Treatment:  Gift made to GRAT requires gift tax return to be filed. During fixed term, Grantor Trust under IRC §677 as to income and IRC §673(a) as to principal. Upon expiration of fixed term, possibly a Grantor Trust depending on the terms of the GRAT.

 

h. Education/2503(c) Minor Trust

Definition: A trust that receives gifts equal to the annual exclusion amount by the Grantor for the benefit of a beneficiary under the age of 21. Trust property may be expended for the benefit of the minor; any remaining balance must be distributed to minor at age 21.

Tax Treatment: Grantor utilizes annual exclusion amount under IRC §2503(b) for gifts to trust. No Crummey notice is needed to satisfy present interest requirement. Trust is not treated as a Grantor Trust.

 

i. Generation Skipping Transfer Trust

Definition:  A trust created for the benefit of a skipped person.

Tax Treatment: The trust is usually a Complex Trust; IRC §2642(a) for Crummey notice.

 

j. Charitable Remainder Trust

Definition:  A trust that pays income to designated person during the Grantor’s lifetime. Upon Grantor’s death, remaining trust property distributed to specified charity.

Tax Treatment:   This trust is a split interest trust. The trust must not be a Grantor Trust.

 

k. Supplemental Needs Trust

Definition: A trust which is designed to preserve government benefits a beneficiary may be receiving as a result of a disability.

Tax Treatment:  If self-settled trust, then Grantor Trust. If third party trust, the trust will be treated as a non-Grantor Trust.

 

l. Trusts & S-Corporations:

         i    ESBT

         ii   QSST

         iii  Grantor

         iv  Estate

 

 

 

 

Circular 230 Disclosure: 

 

*** The Treasury Department has newly promulgated Regulations effective June 20, 2005, that applies to those attorneys and accountants (and others) practicing before the IRS that require such individuals to provide extensive disclosure in certain written communications to clients.  In order to comply with our obligations under these Regulations, we want to inform you that since this communication is not intended to and does not contain such disclosure, you may not rely on any tax advice contained in this document to avoid tax penalties.

Tags: Estate Law, Dynasty Trusts, Estate Planning, Life Estates, Asset Protection