Trusts consist of a grantor, a trustee, and at least one beneficiary. The grantor creates the trust, then funds it by transferring assets to it. We may not think of trusts as profit centers, but some trusts do generate income. This, of course, leads to the question, “Do trusts pay income taxes?” Whether they do or do not depends on several factors, starting with the type of trust involved.
These two classifications of trust relate to whether income tax is paid or not. A simple trust distributes all of its income, while a complex trust retains some of the income. Of course, beneficiaries pay income tax on distributions they receive from their trust fund. However, complex trusts are, as you might expect, a little more complicated.
Distributions to beneficiaries are deducted from the trust’s annual income. As noted above, the beneficiary reports the income on their tax return and may pay income tax, depending on all other factors. The distribution comes first from that year’s trust income, then from the trust’s principal.
Other deductions from the trust’s income may include a $600 tax exemption, fees and administrative costs, and expert fees.
The trustee of a trust must file Form 1041 with the Internal Revenue Service if:
A trust typically has its own tax identification number, which will be used when filing the trust’s tax return. In addition to income taxes, trusts may owe capital gains taxes if trust assets are sold.
The above guidelines apply to irrevocable trusts. During the life of the trust’s grantor, revocable living trusts typically will not need to file Form 1041.
Always retain the help of legal counsel when forming and managing a trust. Trusts can be complicated, as is tax law.
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