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  • Trust Tax Statuses
  • Choosing the Status
  • Compare Tax Statuses

Selecting the Tax Status of a Trust

With a trust, the creator of the trust can elect one of three tax options for the trust:

  1. Grantor Trust. Here, the trust income passes through to the creator, and the assets of the trust are considered a part of the creator's estate for estate tax purposes. Example: most qualified personal residence trusts.
  2. Non Grantor Trust. Here, the trust itself is taxed on its income under the trust taxation schedules, and the assets of the trust are not considered a part of anyone's estate for estate tax purposes (unless a special power of appointment is used).
  3. Defective Grantor Trust. Here, the trust income passes through to the creator, but the assets of the trust are not considered a part of anyone's estate for estate tax purposes (unless a special power of appointment is used). Example: the intentionally defective grantor trust.

 

2010 Health Care Act/Affordable Care Act surtax on trusts

As a part of the Internal Revenue Code changes to pay for the Affordable Care Act, Internal Revenue Code 1411 was modified, adding a 3.8% surtax on what the legislature deems to be highly paid Americans. It will be on the lesser of (a) net investment income, as defined by the section, or (b) on the amount by which the modified adjusted gross income exceeds a threshhold--$250,000 for married filing jointly, or $200,000 for all other taxpayers.

Trusts are treated differently, but only taxable trusts. Grantor trusts would pass all income and losses through to the grantor, and IRC 1411's calculation would look at the grantor's overall return.

Non-grantor or defective grantor trusts will be taxed at a rate of 3.8% on the lesser of (a) the undistributed net investment income for the year or (b) the excess of the adjusted gross income for the year less the dollar amount of the beginning of the highest trust income tax bracket, which is approximately $11,000 in 2012.

Options to have income pass through to the trust creator per Internal Revenue Code §§ 671–79: have your trust contain

  1. a reversionary interest in the income or principal of the trust that exceeds five percent of its value; 
  2. the power to control the beneficial enjoyment of the income or principal of the trust; 
  3. the power to purchase, exchange, or dispose of trust principal for less than adequate consideration, borrow money from the trust without adequate interest or security on the loan, or retain general administrative powers over trust assets such as the power to reacquire trust assets by substituting other property of an equivalent value; 
  4. the power to revoke the trust and reclaim the assets; and/or
  5. a right to income for himself or herself or for a spouse without the consent of an adverse party or the right to the trustee to pay premiums on life insurance on the grantor or his or her spouse.

In addition, individuals other than the grantor can be treated as the owner of a trust for income tax purposes, if the individual has the sole right to vest the principal of the trust in himself, or if he/she transfers assets to a foreign trust with a United States beneficiary.

Options to have assets included in the estate of the trust creator per Internal Revenue Code §§ 2035–42: have your trust's creator

  1. retain, for his or her life, the right to possess or enjoy the property transferred to the trust; 
  2. retain, for his or her life, the right to the income from the property transferred to the trust; 
  3. retain the right to designate who will possess or enjoy the trust property; 
  4. retain a reversionary interest in excess of 5% of the transferred property; 
  5. retain the right to alter or amend or revoke the trust; 
  6. be deemed to have retained a general power of appointment over the trust assets; 
  7. be deemed to have retained an incident of ownership over a life insurance policy or transferred to trust; 
  8. make a transfer of, or relinquish any of the foregoing rights within three years of death.

These provisions are complicated, and it is for that reason that we advise you consult a professional instead of trying to do it yourself.

Do I need to file another tax return for my trust?

Perhaps not you, but a fiduciary to the trust will need to file Form 1041 if the trust has any taxable income, gross income in excess of $600, or if any trust beneficiaries are nonresident aliens.

  Grantor
Non Grantor

Defective Grantor

Income Tax paid by trust creator
Income Tax paid by trust on trust schedules
Property included in grantor estate at death
Property excluded from estate
Property receives step-up in basis at death
Treated differently for the 2010 Health Care Act, Internal Revenue Code 1411
 —  A right of substitution may allow for a step-up in basis to be achieved, given the right circumstances and properly planning during the life of the grantor.