Living Trust Taxes
We get lots and lots of questions about living trust taxes. Mostly, they all boil down to one:
Does a living trust save taxes?
Saving taxes is commonly cited as an advantage of living trusts. That really is a myth.
Living trusts do not inherently save taxes.
Living trusts can be used as a tool to save taxes, as can a testamentary trust. See Credit Shelter Trusts. But, there is no unique tax advantage specific to a living trust.
There are principally two taxes to discuss when talking about living trust taxes. They are:
- Income Tax, and,
- Estate Tax.
As discussed at What is a Living Trust?, the most common type of living trust is a revocable living trust.
If you have a revocable living trust, you can revoke it at any time. You can name yourself as the trustee and use the assets in the trust however you like. In fact, you could put your checking account in the revocable living trust and continue to pay your personal bills from that account as always.
So, you probably aren't surprised when I tell you that, for tax purposes, income earned by that revocable living trust is attributed to you as trustor of the trust.
You will pay income taxes on the income the trust earned just as if it was your income. Because, for tax purposes it is. You control it.
Your social security number will be the taxpayer identification number for the trust. [This is why you probably should not get a separate tax ID for the revocable living trust as that will only confuse matters.]
While you are trustee or co-trustee, no separate income tax returns are required to be filed for living trust. You will simply report the trust's income and deductions on your personal return.
Even if you are not the trustee of the revocable living trust – as long as you retain the power to revoke the trust, it is still considered yours for tax purposes. The trustee would file an information return with the IRS and any trust income would be attributed to you and reported on your personal return.
After your death, the IRS has a new problem. You are no longer "available" to pay taxes on the trust income.
No problem. At that point, the trust becomes a separate tax entity and pays its own income tax. [This is the same thing that would happen if the assets passed through a will (instead of a living trust) and earned income while in probate.]
O.K. – enough about living trusts and income taxes. What about living trusts and estate taxes?
That's easy!
Assets in your revocable living trust will be considered part of your estate and will be subject to estate tax. Whether estate tax will have to be paid will depend on whether your estate is valued above or below the estate tax exclusion amount at the time of your death. See Estate Tax for a discussion of whether your estate will have to pay estate taxes.
So, as you can see, when it comes to living trust taxes – the tax laws actually make sense.
If you control the trust – you, or your estate, will pay income and/or estate taxes on the assets in the trust – just as if they were not in the trust.
There is simply no inherent tax advantage to placing assets in a living trust.
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