The topic of Living Trusts can be confusing and complex in nature, especially when it comes to taxation. In this article, I will clarify the way a basic grantor revocable living trust is taxed.
What is a trust?
Understanding a grantor trust is the first point when considering how a trust is taxed. By definition, a trust is an estate planning tool that creates a relationship where three different roles are created. The first role is called the grantor or the trustor. The grantor is the party that creates the trust. The second role is called the trustee. The trustee is the party that holds trust property/assets and manages the trust. The third role is the beneficiary. The beneficiary is the party that benefits from the trust.
Trusts establish a fiduciary relationship where the grantor’s property /assets that are placed in the trust are held and managed by the trustee for the benefit of a beneficiary. A grantor may decide what property he or she wishes to include in the trust, who the trustee will be, who the beneficiaries will be, and how the trust property/assets are to be distributed by the trustee for the beneficiaries.
Who Can Control the Trust?
A grantor trust is a type of trust that is usually revocable, meaning that the grantor can end or change the terms of the trust during his/her lifetime at any time, and the grantor is considered the owner of the trust. A grantor has ownership over the trust if the grantor has the power to affect the disposition and allocation of the trust property or income without the consent of an adverse party. In short, a grantor trust is a trust in which the grantor owns is the trust property and has control over the property without needing the consent of others. The IRS defines when a grantor is considered an owner of a trust in 26 U.S. Code §674(a).
How is a grantor trust taxed?
When a trust is taxed as a grantor trust, the trust income and property are taxed to the individual grantor on his/her individual tax returns. This type of tax structure views the trust as a “disregarded entity,” meaning that the trust entity is not considered in the grantor’s taxes, and the IRS views all the trust property and income as property and income of the individual grantor. Even though there is a separation between the grantor and the trust property/assets, the IRS will view both together, as one under the individual grantor taxes.
Trusts may be created in circumstances where the trust is not a grantor trust. When a trust is not a grantor trust, the trust is taxed on the trust income at rates as high as 37% where trust income exceeds $13,050.00. It can be tax advantageous to create a grantor trust in an estate plan because many individuals will not find themselves in an income tax bracket lower than 37%, so any trust income will be subject to the individual’s tax bracket, rather than the trust tax bracket.