One of the most popular estate planning tools is a trust, due in large part to the numerous and varied estate planning goals that can be furthered using a trust. If you are considering the addition of a trust to your estate plan, you will need to decide what type of trust you need, who to appoint as the Trustee, and ensure that you understand the tax implications of your trust. For example, do you have to pay taxes on money from an irrevocable trust?
Trust Basics
A trust is a relationship whereby property is held by one party for the benefit of another. A trust is created by a Settlor, also referred to as a “Grantor,” who transfers property to a Trustee. The Trustee holds that property for the trust’s beneficiaries. A trust is created using a trust agreement. The trust agreement includes terms, created by the Settlor, that dictate how the trust is to be administered. All trusts fall into one of two broad categories – testamentary or living trusts. A testamentary trust does not activate until after the death of the Settlor, usually through a provision in the Settlor’s Will. A living trust, on the other hand, will activate during the Settlor’s lifetime once all elements of creation are in place. A living trust can be further divided into revocable and irrevocable living trusts whereas a testamentary trust is always revocable. The type of trust you create, your role in the trust, and the source of the funds in question will all help determine what taxes are owed and by whom.
Taxes and Revocable Trusts
Both the law and the I.R.S. view the assets held by a revocable and an irrevocable trust differently. Specifically, because the Grantor if a revocable trust retains control over the assets held by the trust, those assets continue to be considered part of his/her estate. As such, any interest earned by the trust must be reported on the Grantor’s income tax return and any tax owed on that money must be paid by the Grantor. Similarly, any assets held in a revocable trust at the time of the Grantor’s death are considered part of the Grantor’s estate and are, therefore, subject to gift and estate taxation. The beneficiary of a revocable trust, on the other hand, is never required to pay taxes on the value of assets h/she received from a revocable trust because the taxable event has already occurred. In other words, the Grantor, or the Grantor’s estate, has already paid the gift and estate taxes, if any are due, on the assets.
Taxes and Irrevocable Trust
An irrevocable trust, on the other hand, is considered a separate and distinct entity for legal and tax purposes because once assets are transferred into the trust the Grantor no longer controls those assets. Consequently, an irrevocable living trust must file a tax return every year and pay any taxes due. As a general rule, a taxable event occurs when assets are transferred into an irrevocable trust. Beneficiaries who receive income from an irrevocable trust are also generally responsible for reporting that income on their personal income tax return and paying any taxes due on it. If the beneficiary is receiving a portion of the trust principle, however, that beneficiary is generally not responsible for paying taxes on those assets because any taxes due were already paid at the time the assets were transferred into the trust.
As you can see, questions regarding the potential tax consequences of money or assets transferred into or out of a trust are complicated to answer. Numerous factors can impact whether or not taxes are owed and, if so, by whom. For this reason alone it is in your best interest to consult with an experienced trust attorney to ensure that you understand the tax consequences of a specific trust or transaction.
Contact Illinois Trust Lawyers
Please join us for a FREE upcoming seminar. If you have questions or concerns regarding the tax consequences of an irrevocable trust, contact the experienced Illinois trust attorneys at Hedeker Law, Ltd. by calling (847) 913-5415 to schedule an appointment.
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