Setting up a trust fund is one way you can ensure that your children or others will be taken care of in the future—even after you’re gone. However, you and your beneficiaries will also have to deal with some complicated IRS regulations that will affect those assets. To help, below are three things you need to know about trust fund taxes.
Revocable and Irrevocable Tax Funds Pay Taxes Differently
How a trust fund is taxed will be determined by whether or not the trust fund is revocable or irrevocable. One difference is a revocable trust fund can be changed if the grantor, the person who sets up the trust and owns the assets, changes his or her mind. An irrevocable trust cannot be.
However, another big difference is how each is taxed by the government. If the trust is revocable, any profit that is made by the assets held within the trust will treated as if it is the income of the grantor. This changes if the trust fund is irrevocable. If this is the case, the trust fund itself will actually be treated as an entity separate from the grantor. Any taxes paid on income produced by the irrevocable trust must be paid from funds within the trust. The trustee, the person assigned to manage the trust, will be the one to fill out the forms. The grantor will not have to worry about it.
The Estate Tax May Be Applied
The estate tax is designed to be paid on the estate of a deceased person. This is generally paid by the beneficiaries that receive the assets. Trust fund beneficiaries unfortunately may be forced to pay this tax. This is the case for revocable trust funds. If the grantor dies, these laws will be applied to the funds that are given to the beneficiaries if they exceed $5,340,000.
However, there is one way to avoid them entirely. If the trust fund is set up as an irrevocable trust, it is treated as a completely separate entity. As such, the grantor’s death will have no effect on how taxes are paid and the estate tax will be avoided.
The Gift Tax May Also Be Applied
Lastly, the gift tax may also be applied to the assets in a trust fund. The federal gift tax is applied on property a person receives for nothing else in return. Currently, there is an annual exclusion of $14,000. The gift tax will not be applied to any gift of $14,000 or less. The current rate is 40%. This can certainly be a lot of money to be paying to the government.
Gift taxes will more than likely have to be paid when dealing with trust funds. How they are paid is based on whether the trust fund is revocable or irrevocable. If the trust fund is revocable, it will be applied when the assets are given to beneficiaries. When it is an irrevocable trust, it is applied when funds are moved into it. This is because the irrevocable trust is considered a separate entity from the grantor.
Thankfully, the gift tax is only paid by the one giving the gift. This lessens the burden for beneficiaries. If the gift is given to a person’s spouse, the gift tax will not be applied.