Do Tax Return Filing Rules for Trusts Have You All Twisted Up?

One of the most common estate planning questions is whether the creation, or more specifically, the funding, of a Trust creates an additional tax filing requirement.  In other words, once I fund the Trust with assets, and those assets create income during the tax year, do I need to file an income tax return in the name of the Trust? 

No.  No, you don’t. So long as the grantor(s) of the Trust remains alive, no separate income tax return is needed.  

What is a Grantor Trust?

A Grantor Trust is how the IRS refers to any Trust in which the person (or persons) who created the Trust retains control over the assets in the Trust.  For example, he/she has the power to decide who receives Trust income, or the power to control the investment of trust funds.  All revocable trusts are grantor trusts.  Why? Well, by definition they are revocable.  That means the grantor can change, amend, alter, or even destroy the Trust.  Therefore, the grantor exercises control.  

Some Irrevocable Trusts are also considered Grantor Trusts. Even though an Irrevocable Trust cannot be modified, if the Trust terms create certain ownership requirements for the Grantor(s) (as specified in 26 U.S. Code (IRC)  §§ 671, 673, 674, 675, 676, or 677), an Irrevocable Trust can also be classified as a Grantor Trust. Simplicity stated, if the Grantor retains an interest in the Trust assets, then that amount is taxable to the Grantor.

During the Grantor’s lifetime, the income from the Trust is reported on the personal income tax returns of the Grantor(s), and not on a separate return. 

What Happens When the Grantor Passes? 

When the Grantor to an individual Trust, or one of the Grantors to a joint Trust, passes, two things happen.  First, the estate of the passing Grantor must file an individual income tax return (Yes, even after you die you pay taxes!).  Second, fiduciary income tax returns are due at the federal and state (California/Hawai’i) level for that portion of the Trust that was owner by the passing Grantor.

So for example, in the case of a typical joint revocable trust, the Trust assets are divided between the passing spouse and the surviving spouse. The passing spouse’s Trust property changes into an irrevocable trust and income from those assets must be reported on a fiduciary income tax return. The Personal Representative/Trustee of the passing spouse (usually the surviving spouse), would apply for a federal tax ID # and file tax return on behalf of both the passing spouse individually (pre-death income) and on behalf of the Trust (post-death income from Trust assets.) So long as the irrevocable trust continues in existence and meets certain state and federal minimum income thresholds, tax returns must be filed on behalf of the Trust.  

Takeaway

How you structure your Trust has tax implications not just on whether you will be filing tax returns in the future, but how much tax you will owe.  If you have questions about how to structure your estate plan to achieve the results you want, and avoid the unintended consequences of a poorly drafted plan Contact CASHMAN LAW today for a free consultation to see how we might assist. 

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