Trust beneficiaries may need to pay taxes on distributions.
A trust is a useful estate planning tool.
It holds assets and distributes them to the trust beneficiaries according instructions provided in the trust itself.
It also provides greater control and protection of assets in estate planning.
A common question with estate planning involves whether beneficiaries of an irrevocable trust pay taxes on distributions.
According to a recent Investopedia article titled “Do Trust Beneficiaries Pay Taxes?,” the answer dependents primarily on accrued principal.
In general, the IRS treats money held in a trust as if it has already been taxed.
After assets are placed in a trust, however, they often accrue interest.
This interest is considered new taxable income.
The trust will owe the taxes on any interest remaining in the trust after the end of the year.
If the trust distributes income interest to the beneficiaries, the trust beneficiaries pay the taxes.
Anytime a trust makes a distribution, it will deduct distributed income from its own tax return.
The trust beneficiary is issued a K-1 tax form.
What does the K-1 form do?
It informs the beneficiary how much they must claim as taxable income from the trust when filing his or her personal income tax return.
The amount distributed from the trust to beneficiaries is considered to belong first to the income of the current year.
Excess of this is then considered accumulated principal.
The capital gains from the accrual can be paid by either the individual or the trust.
If the trust deducts the amount, the trust beneficiaries then pay.
Tax Form 1041 is the form the filed by the trust where it makes deductions based on interest distributed to the beneficiaries.
The K-1 is generated by the trust and given to the IRS.
The IRS then provides the trust beneficiaries with the document so they can pay the taxes.
Whether the trust beneficiaries or the trust owe the taxes on the income, the process for determining who pays is straightforward.
Reference: Investopedia (Feb. 8, 2020). “Do Trust Beneficiaries Pay Taxes?”