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Are Estate Planning Trusts Taxable?


Trusts are commonly used in estate planning as a means of transferring assets without the need for formal probate. In some scenarios, a trust may also confer certain tax benefits. But it is important to understand how taxes actually work with respect to trusts.

Federal Income Taxes and Revocable Trusts

Florida does not assess individual income taxes. But obviously, most of us still need to file a federal Form 1040 with the Internal Revenue Service each year. So what happens when a Florida resident places assets in a living (or inter vivos) trust for estate planning purposes?

Basically, nothing happens, at least while the person who made the trust (known as the grantor or settlor) is still alive. With most living trusts, the grantor also serves as trustee. If the trust is made by a married couple, the spouses may serve as co-trustees. And under the Internal Revenue Code, the grantors are still considered the legal “owners” of the trust assets.

In other words, let’s say you create a living trust and transfer assets into it. The income earned by those assets is taxable. However, the trust does not file a separate tax return. Instead, you must include the trust’s income on your own Form 1040 each year.

Now, if someone else serves as trustee, either because you die or become incapacitated, then it may be necessary for the new trustee to obtain a separate tax identification number for the trust. The successor trustee will also then need to file a separate tax return to report the trust’s income, which is known as a Form 1041.

It is also important to note that assets in a revocable trust are not in any sense “tax exempt.” The same IRS regulations apply regardless. If you are looking to reduce your overall income tax liability, you may wish to consider an irrevocable trust instead.

Irrevocable Trusts

An irrevocable trust is basically one where the grantor makes a gift of certain assets to a trustee, who is not the same person as the grantor. Once made, the trust cannot be modified or revoked by the settlor. That means the property in the trust no longer belongs to the settlor for income tax purposes.

Of course, there may still be tax owed on the trust’s income. But that is the responsibility of the trustee, or in some situations the beneficiaries entitled to receive the trust’s income. It is no longer the settlor’s responsibility.

There are also special types of irrevocable trusts tied to charitable gifts. For example, a charitable remainder trust allows the settlor to provide income for one or more beneficiaries–usually family members–for a fixed period of time, after which the “remainder” goes to an IRS-recognized charitable organization. The settlor then receives a charitable income tax deduction for the property gifted to the trust.

Taxes and estate planning are complex legal matters. It is therefore in your best interest to work with an experienced Fort Myers estate planning lawyer who can advise you on the best strategy for your family. Contact the Kuhn Law Firm, P.A., at 239-333-4529 to schedule a free consultation with a member of our estate planning team today.

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