Tax Planning for Trusts
Trusts and estates are an interesting tax entity that can generally be described as a hybrid between a partnership and an individual for tax purposes. The reason being that a trust may have a tax liability, or it may passthrough its income to the beneficiary. The determination depends on how the trust is established and administered.
Grantor Trust
A grantor trust is a type of trust in which the property of the trust is generally treated as being owned by the grantor (the person who established the trust). A grantor trust is disregarded for income tax purposes and is used by wealthy families for estate tax planning.
Non-Grantor Trust
Non-grantor trusts are trusts that are generally treated as a separate legal entity. If a trust is not a grantor trust, it is considered a non-grantor trust. There are two types of non-grantor trusts, simple and complex trusts.
Simple Trust
Despite its name, a simple trust has little to do with the lack of complexity of the trust. A simple trust is a trust that is required to distribute all its income each year. In general, a simple trust is not entitled to accumulate income or distribute corpus. If a trust distributes corpus, the trust becomes a complex trust. A trust can alternate between simple and complex. To determine if a trust is established as a simple trust, the trust document should be examined to determine if income distributions are required annually.
Complex Trust
A complex trust is a trust that fails to qualify as a simple trust. A complex trust may accumulate income, make discretionary distributions of income and corpus, and make distributions to charity.
Trust Tax Rates
Trusts and estates have a compressed tax bracket. In 2023, the top tax rate of 37% applies to taxable income over $14,450. In comparison, the top tax rate of 37% for those filing married filing jointly applies to income over $578,125. The net investment income tax of 3.8% will apply at those income levels and can be a surprise to the unprepared.
The 65-Day Rule for Trusts
There is a tax planning opportunity, when appropriate, to make distributions to beneficiaries to shift the tax liability from the trust to the beneficiary. The reason for this is that the individual beneficiary is generally a lower income tax bracket and will owe less tax on the same income.
If adequate distributions are not made during the calendar year, trustees and fiduciaries should consider making distributions under the 65 day rule. The 65 day rule allows trustees and fiduciaries to make distributions to beneficiaries up to 65 days after the end of the tax year and count them towards the previous tax year. A Houston CPA can help determine whether a 65 day rule trust distribution makes sense for your situation.
About The Author
Christopher Sternau is a Certified Public Accountant and Certified Financial Planner with over a decade of experience providing comprehensive tax and financial planning services to several of the wealthiest families in the United States. He focuses his practice on complex individual and closely held business tax planning and preparation. His clients have business interests in a wide range of industries including oil and gas, mining, real estate, cattle ranching, retail, technology and many others.
Chris is the founding member of Evans Sternau CPA LLC. Prior to founding Evans Sternau CPA LLC, Chris led the tax department for a family office in Houston, Texas. He also spent several years as a Tax Manager at Andersen.
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