A living trust is a common solution for many people with estate planning needs. However, few people know about its tax-filing requirements. Generally, any trust with at least $600 in annual income must file a federal return. But for a revocable trust or a grantor trust that is controlled by the person who set it up, those owners must include the trust on personal returns and the trust itself doesn’t file. Here’s what you need to know.
A financial advisor could help you find answers to your trust and taxation questions.
Living Trust Basics
A living trust is one of several varieties of trusts often used in estate planning. A living trust is an instrument that can be used to control where one’s assets go either before or after death. It can help heirs skip probate, avoid conservatorship in the event of incapacitation and specify how assets will be left to minor children, among other things.
To set up a living trust, an attorney draws up the documents creating the trust. Then assets are transferred to the control of a trustee overseeing the trust. The trustee can the original owner of the assets, called the grantor, or someone else appointed by the grantor. The trustee is charged with managing the assets for the benefit of the named beneficiaries.
Living trusts come in a number of varieties. Transfer of assets to irrevocable trusts can’t be reversed. Revocable trusts allow the grantor to change or cancel the terms of the trust. Marital trusts are a type of irrevocable living trust allowing transfer of assets to a surviving spouse without taxation. Grantor trusts, in which the grantor retains control of assets are treated like revocable trusts for tax purposes.
Living Trust Tax Filing Requirements
A trust with more than $600 in income during a tax year is required to file a federal income tax return. The trustee files out a Form 1041 reporting the trust’s income. Even if it does not report $600 income, a trust must file a return if it has a non-resident alien as a beneficiary. However, there are exceptions to this rule.
One exception to this rule is a grantor trust, one in which the grantor of the trust retains control over the assets in the trust. In the case of a grantor trust, the grantor has to report the trust’s income on his or her personal 1040. The grantor is also responsible for paying any taxes due on the trust’s income.
Another exception to the rule that living trusts must file tax returns is a revocable marital trust in which both spouses are living. In this case the income from the trust’s assets is reported on the spouses’ personal returns and the trust does not file a Form 1041.
When one spouse dies, however, things change. At that point, the portion of that spouse’s assets in a revocable living trust become irrevocable. The trust must file a Form 1041 for that year, reporting and paying taxes on the income from the deceased spouse’s portion of the assets. This is typically half the trust’s assets. Afterward, the irrevocable trust will file a return, subject to the income level requirements, every year.
Trusts also must provide a tax form called a Schedule K-1 and supply it to beneficiaries of the trust. This will sum up any funds the trust distributed to beneficiaries. The beneficiaries of the trust have to report any receipts from the trust on their own personal returns.
Living trusts have to file tax returns in most cases if they have $600 or more in income for a given tax year. They may also have to file if the living trust is a grantor-controlled trust or a revocable marital trust and both spouses are still living. Trusts that file tax returns do so using Form 1041. However, the grantors of grantor-controlled and revocable trusts report the trust’s income on their own personal returns. Living trusts also supply Schedule K-1 forms to beneficiaries outlining and funds paid to them during the year as benefits.
Estate Planning Tips
- Living trusts can be effective tools for estate planning, but they are best used with the help of a financial advisor. Finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Estate planning can be complex, and that’s especially true if you’re someone with significant wealth. To make sure you have everything you need, read up on the essential estate planning tools for wealthy investors.
- Inheritance isn’t usually considered income, but certain types of inherited assets can have tax implications. Before you spend or invest your inheritance, read more inheritance taxes and exemptions.
Photo credit: ©iStock.com/TwilightShow, ©iStock.com/Panupong Piewkleng, ©iStock.com/GCShutter