Using a trust may be a great way to smooth the process of controlling your assets through disability and old age. They may also be great will alternatives, or an essential part of caring for a disabled loved one. However, a trust is a separate, taxable entity in many cases, and it is important to understand how using a trust affects your taxes.
Generally, a trust where you are both beneficiary and trustee is just taxed as part of your normal income. In these trusts, there is no real wall between you and the assets, and you still control everything, so it is taxed normally on your taxes. If a trust is truly a separate entity, it is often taxed as such, and it may have a higher tax rate than a person would.
For help setting up a trust and understanding the potential tax benefits and pitfalls of your setup, call the Henderson, NV trust attorneys at Flake & Flake today at (702) 829-5731.
Revocable vs. Irrevocable Trusts
In general, trusts are revocable if you can take back the money/assets in the trust, and they are irrevocable if you cannot. If there is very little separation between control and benefit, the trust is likely to just be taxed as part of your own money/income/assets.
A living trust is one of the most common revocable trusts, where the grantor is listed as both the trustee and beneficiary. This common type of trust is just taxed as the grantor/beneficiary’s own money/assets.
IRS Designation
Instead of using revocable vs. irrevocable to determine taxes, the IRS puts trusts in three categories:
- A “simple trust” is its own entity. The trust will distribute all income, keep all principal in the trust, and make no charitable contributions.
- A “complex trust” is more complicated because it either keeps some income, distributes some principal, or distributes to charities.
- A “grantor trust” is when the grantor is the beneficiary and the trustee. This is usually a revocable trust, and the beneficiary is just taxed on the trust’s income as part of their personal taxes.
Both simple and complex trusts are taxed as separate entities, but grantor trusts are usually just taxed as part of the grantor/beneficiary’s own assets/income.
When Do Taxes Affect a Trust
Money and property are not usually taxed for simply existing, but rather when a transfer happens. The same is true with trusts and money/assets in a trust: there usually needs to be a change or transfer for taxes to take hold.
Granting/Funding a Trust
When money is put into a trust, it is a transfer. This often makes it subject to either the estate tax or the gift tax.
There are high limits before either of these taxes take effect, with the total lifetime limit before taxes kick in at $15 million. In a year, the gift tax exemption is $19,000 per recipient (i.e., the trust), with married couples being able to give double that ($38,000) before taxes kick in.
Only the money that exceeds these limits is taxed, so if you fund a trust when you pass, it would typically only be taxed on amounts over $15 million.
Income
If the trust makes money, that money is taxed. The tax brackets for a trust have lower thresholds than for an individual or married couple filing jointly. There are also only three brackets, while individuals and couples have seven brackets.
This means trust income is typically taxed more, but it can still benefit from various deductions and credits like any other taxpayer.
Capital Gains
Trusts are often used to manage capital assets – assets owned for more than a year. These are taxed at a different tax rate, and usually only when they are sold or the increase in value is recognized in some way.
Transfer or Death of Beneficiary
Transferring a trust to another beneficiary – usually because the beneficiary died – may incur a tax, depending on the type of trust it is. Nevada’s “Dynasty Trust” switches to a new generation’s beneficiaries every 25 years and lasts up to 365 years, all with no transfer tax between generations.
Other trusts may face taxes every time they transfer to a new beneficiary. Other trusts, such as a special needs trust, usually cannot pass to a new beneficiary and revert to the state when the beneficiary dies.
Do Trusts Pay State and Federal Income Tax?
Yes. This means that trusts formed and managed in Nevada just pay federal income tax, since we have no state income tax in Nevada.
Are Trust Distributions Taxed in Nevada?
The distributions that trusts pay to the beneficiaries are where taxes truly get complicated. Our Nevada trust attorneys can help advise you of the tax implications of various trust setups, but the tax on the distributions is usually left to accountants and tax attorneys for the trustee or beneficiary.
Trust “Income” is Not Payroll Tax
Confusingly, FICA taxes (which cover Social Security Disability and Medicare) are sometimes called “trust fund taxes.” Also known as “payroll taxes,” these are the taxes that an employer withholds when they pay income, which they are “trusted” to pay to the government to “fund” programs.
Despite the name, these taxes have nothing to do with trusts, and the “income” paid out of a trust is not “payroll” income that would face those payroll taxes. This means trusts do not withhold FICA/Social Security/Medicare taxes when they pay out “incomes.”
Do Trust Beneficiaries Pay Tax on Income?
Beneficiaries usually pay taxes on the distributions they receive from a trust, but what amounts are taxed may vary. For example, if the distributions are paid from the income the trust made that year, they are usually taxable, but distributions from the trust’s principal might not be.
In some cases, the trust may be the one to pay the income tax rather than the beneficiary. Both the trustee and the beneficiary should always check with tax professionals to determine what amounts need to be withheld, when quarterly estimated tax payments are needed, and what income amounts should be included on their tax returns.
Grantor Trust Rules
Remember that if you have a “grantor trust,” such as a living trust where you are both trustee and beneficiary, then the trust income is taxed to your personal income taxes. Distributions are not taxed as income a second time, because they are more like passing money you already received from one account to another rather than paying another person.
Call Our Trust Lawyers in Nevada Today
For help setting up a trust in Nevada, call Flake & Flake’s Las Vegas, NV trust attorneys at (702) 829-5731.
