Tax Bite Varies Depending Upon the Type of Trust Used for an Estate
Planning in advance can save money later
As most people have heard, trusts are perhaps the most useful tool in estate planning. They help manage assets during life and long after we are gone.
When you place assets in a trust, the trust gets legal title to the assets.
But, who pays income tax on interest, dividends, gains and other income generated from the assets when they are in the trust? This depends on the type of trust.
For income tax purposes, there are generally two types of trusts, “grantor” trusts and “non-grantor” trusts.
With a grantor trust, all of the income and deductions flows to the income tax return of the creator of the trust, the “grantor.” In fact, a grantor trust typically uses the social security number of the grantor as its taxpayer identification number.
A revocable living trust, the most common type, is a grantor trust while the grantor is alive. Certain powers held by the creator of the trust, such as the power to revoke the trust, cause the trust to be a grantor trust.
Other technical administrative powers also can cause a trust to be a grantor trust.
If a trust is not a grantor trust, it is a non-grantor trust. With a non-grantor trust, the trust has a separate taxpayer identification number, which is like the trust’s own social security number.
The TRUST’S income and deductions go on its own return. While an individual files a Form 1040, a non-grantor trust files a Form 1041.
If such a trust makes distributions to a beneficiary, in general those distributions carry any taxable income the trust has to the beneficiary, up to the amount of the distribution.
So, if the trust earns $1,000 of income and distributes $400 to a beneficiary, $400 of income is taxed to the beneficiary and the trust gets an offsetting deduction, so that $600 is taxed to the trust itself.
If the trust has the same income and distributes $3,000, the full income of $1,000 is taxed to the beneficiary and nothing is taxed to the trust. The additional $2,000 is considered a distribution of principal and is not taxed to the beneficiary.
If a non-grantor trust is considered to be a Hawaii trust, then Hawaii Income Tax Form N-40 must be filed for the trust and there may be income tax due to the State of Hawaii. There are times when a non-Hawaii non-grantor trust will require Hawaii income tax reporting for income considered Hawaii income.
For example, a non-Hawaii trust owing rental property in Hawaii needs to file Hawaii income tax returns.
Of course, if you are a trustee, it is important to consider the income tax brackets of the beneficiaries and of the trust itself when deciding on when and to whom distributions should be made.
An attorney specializing in tax and estate planning can help you plan or
administer a trust in a manner that maximizes tax savings while minimizing
headaches.
This information is provided by Judith Lee Sterling, Atty at Law, CPA, Certified Estate Planning Law Specialist. She is so certified by the American Bar Association (ABA) accredited Estate Law Specialist Board, Inc. and so certified by the Supreme Court of Hawaii. The Supreme Court of Hawaii grants Hawaii certification only to lawyers in good standing who have successfully completed a specialty program accredited by the ABA. Judith Sterling can be reached at judy@sterlingandtucker.com or by telephone at (808) 531-5391.
Legal Disclaimer
This information has been provided for informational purposes only. It does
not constitute legal advice. The receipt of this information does not establish
an attorney-client privilege. Proper legal advice can only be given upon consideration
of all the relevant facts and laws. Therefore you should not act upon any
of the information contained herein without seeking appropriate legal counsel.
Attorneys Judith Sterling and Michelle Tucker are both CPAs and licensed attorneys. They are the first two attorneys in Hawaii to be certified by the American Bar Association (ABA) accredited Estate Law Specialist Board, Inc., as Estate Planning Law Specialists, and are so certified by the Supreme Court of Hawaii. The Supreme Court of Hawaii grants Hawaii certification only to lawyers in good standing who have successfully completed a specialty program accredited by the ABA.
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