October 6, 2015
It has become apparent that in the last few years an increasing number of families have become involved with trusts as an integral part of their estate and financial planning. It is of particular concern that taxpayers understand that whatever income is generated by the trust, income tax on that income must be paid by somebody, usually either the beneficiaries or the trust. Because a trust is a separate entity apart from its grantor, trustee, or beneficiary, the trust must acquire its own identification number, or F.E.I.N, and file its own income tax return.
If the terms of the trust require all income to be distributed by the trustee, then it is what is called a “Simple Trust” and the income is taxed to the beneficiaries whether distributed or not.
If the terms of the trust do anything else but require income to be distributed, then income will be taxed to any beneficiary who receives a discretionary distribution, or if retained in the trust, the income will be taxed at the trust level. This type of trust is referred to as a “Complex Trust.”
Who is the ultimate taxpayer is a question that can be important because of different income tax rate schedules for trusts versus individuals. On a taxable income base of $12,150, a trust is paying $3,140 and 39.6% of any taxable income in excess of that amount. On the other hand, beneficiaries pay at a graduated rate that rises much more slowly. Thus, in most circumstances, the same amount of taxable income would generate much lower income tax to the beneficiary than to the trust.
However, except for the Simple Trust, in order for the income to be taxed to the beneficiary, the income must be distributed to the beneficiary during that year. Because of delays in data processing by income payers, the government has ruled that a distribution in the first 65 days of the year can qualify as made during the previous year.
When trust property is sold at a gain, there is a capital gain which, unless specifically directed by the trust to be distributed, will remain in the trust and be taxed at the trust level. Most trusts’ capital gains are taxed to the trust because, absent any specific directions in the trust, state law requires the gain stay in the trust. The tax rate for a trust’s capital gain is the same as the individual capital gain rate.
It would appear from the above that timely and full distribution of income, if required or discretionary, should be a procedure followed in almost all trust situations.
Because a specific trust designer or existence of a particular fact situation may require a provision not falling in the choices mentioned above, it is imperative that those of you who have a trust in your estate structure, or are planning to have a trust, review them, and particularly the income distribution provisions, so that you may be assured your trust’s income is receiving the most favorable tax outcome.
If you have retirement on your mind, the big question is this: Are you in a financial position to do so? While nothing replaces the advice of a seasoned advisor, you can take your first step to answering this question by applying a simple 5-step calculation.
If you’re not a fan of Black Friday chaos—you know…the crowds, the rush, the relentless search for a parking space—then ditch the onsite shopping this year while still enjoying the sweet deals.
The Department of Labor (DOL) announced a final rule that allows a much larger pool of employees to earn overtime if they work more than 40 hours per week. Specifically, the DOL raised the salary level for employees who are counted as “exempt” (or unable to earn overtime pay).