Let’s talk about living trusts and taxes. There are four kinds of taxes that are relevant to revocable living trusts:
- income tax;
- estate and gift tax;
- generating-skipping transfer tax; and
- property tax.
In the living trust context, income taxes arise when trust property, such as a home or stock, is sold for a gain.
The estate and gift tax and the generating-skipping transfer tax are additional federal taxes that apply only to wealthy individuals. If you have assets of less than $11 million—or $22 million for a married couple—then you don’t need to worry about these taxes. And property tax refers to the tax levied against the assessed value of any real estate you own. Below are some frequently asked questions about trusts and taxes.
This chapter covers the most common questions concerning livings trust and the income tax and the estate tax.
- Does a revocable living trust pay income taxes?
- Does a revocable living trust decrease income taxes?
- Does a revocable living trust increase income taxes?
- Does a revocable living trust decrease the estate tax?
- Does a revocable living trust need its own taxpayer ID number?
Does a revocable living trust pay income taxes?
The IRS treats a revocable trust as a pass-through entity. During the grantor’s lifetime, any income generated by trust assets is reported on the grantor’s tax return. (Remember, the grantor is the person who created a trust.)
In practice, this means that any income generated by property in your living trust would be reported to your social security number and you’d include that income on your tax returns.
When you pass away, however, your revocable trust will become irrevocable. At that point, the IRS treats it as a separate, taxable entity. Your trust is required to obtain its own taxpayer identification number and file income tax returns.
An irrevocable trust can decrease or avoid paying income tax by distributing the income earned by trust assets to the trust’s beneficiaries.
Does a revocable living trust decrease income taxes?
By itself, a revocable living trust does not decrease your income taxes. This is because the IRS treats it as a pass-through entity.
If you are subject to either the estate tax or the generating-skipping transfer (GST) tax, then a properly designed revocable trust could help minimize those taxes. Individuals that are subject to those taxes, however, also use irrevocable trusts to avoid the estate and GST taxes.
Does a revocable living trust increase income taxes?
Because a living trust is treated as a pass-through entity by the IRS, it does not increase your income taxes.
Does a revocable living trust decrease the estate tax?
The estate tax is an additional federal tax that applies to an estate with greater that about $11 million in assets (or about $22 million for a married couple).
In legal speak, current law exempts the first $11 million or so of a single person’s estate from the estate tax. A married couple is entitled to twice that amount ($11 million x 2 = $22 million).
For an unmarried person, a revocable trust cannot decrease the estate tax. To do so, you would need to use an irrevocable trust. But remember, if your net worth is less than $11 million, the estate tax doesn’t apply to you.
For married couples, a properly drafted revocable trust can be used to ensure that the full $22 million is exempt from the estate tax. The details, however, are complex and beyond the scope of this guide.
The reality is that most people simply don’t have to worry about the federal estate tax.
If, however, you have assets worth $11 million, or expect that they’ll appreciate to around $11 million, you’d benefit from a comprehensive estate plan that includes both a revocable trust and one or more irrevocable trusts.
Does a revocable living trust need its own taxpayer ID number?
The IRS treats a living trust as a pass-through entity. So, you’ll use your social security number when setting up any accounts for the trust. For example, if you’re setting up a brokerage account for investments, you’ll provide the brokerage with your social security number.
Any income generated by trust assets is included on your tax return.
The trust doesn’t get its own taxpayer identification number until you pass away. When that happens, the trust converts to an irrevocable trust and the IRS treats it as its own separate entity.