Planning for Life

What Taxes do Trusts Pay?

Posted by Harry S. Margolis on July 2, 2013

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By Harry S. Margolis

Trusts pay taxes on income like individual taxpayers, whether investment income such as dividends, interest and capital gains, or business income, such as rental income on real estate owned by the trust. Of course, they don't have earned income from work, so they don't pay Social Security taxes.

However, there are two major differences between how income of humans and trusts are taxed. The first is that the tax rates for trusts are significantly compressed as compared to those for individuals.  For instance, the top rate of 39.6 percent kicks in at $400,000 of income for individuals ($450,000 for married couples filing jointly) and at $11,950 for trusts. Here are the rates for 2013:

Tax Rate Individual Married Couple Trust
10%  $0 - $8,925  $0 - $17,850 $0
15%  $8,925 - $36,250  $17,850 - $72,500 $0 - $2,450
25%  $36,250 - $87,850  $72,500 - $146,400 $2,450 - $5,700
28%  $87,850 - $183,250  $146,400 - $223,050 $5,700 - $8,750
33%  $183,250 - $398,350  $223,050 - $398,350 $8,750 - $11,950
35%  $398,350 - $400,000  $398,350 - $450,000  
39.6%  Above $400,000  Above $450,000 Above $11,950

As this chart shows, trusts can end up paying taxes on income at a far higher rate than would individual taxpayers. This is compounded by the introduction this year of a Medicare surtax of 3.8% on investment income earned by trusts (not sure what other kind of income they might have). This surcharge kicks in for individuals with modified adjusted gross income (MAGI) in excess of $200,000 and married couples filing jointly at $250,000 MAGI.

In short, a trust earning $10,000 of investment income will be subject to a marginal tax rate of 36.8%, while an individual receiving the same income may pay a tax of anywhere from 15% to 43.4% depending on her other income. However, remember that for the the trust, not all of the $10,000 will be taxed at the highest marginal rate. Part of the income will be taxed at the lower rates in the chart above.

The second major difference between trusts and human taxpayers is that trusts often don't pay taxes on all of their income, the tax consequences passing through to the creator of the trust -- the "grantor" -- or to beneficiaries. Revocable trusts and some irrevocable trusts, depending on how they are drafted, are considered "grantor" trusts and all income is taxed to the grantor at his marginal tax rate. For those trusts, the trustee and the beneficiaries don't need to be concerned about the trust tax rates.

For trusts that are not grantor trusts -- sometimes called "complex" trusts -- the tax consequences follow the income. So, if the trust income is distributed to beneficiaries they will report it on their own tax returns and pay taxes on such income at their tax rate. If, on the other hand, the trust retains the income it will pay taxes at the trust rates. The choice of whether to distribute income to beneficiaries, therefore, can have a great consequence on the amount of taxes due and this is something trustees of complex trusts need to consider carefully each year.

Fortunately, trustees have a bit more time than most taxpayers to consider these issues. They may distribute income up to 65 days after the end of prior year and the income will be deemed to the beneficiaries rather than to the trust. For instance, if a trustee of a trust with $10,000 of income in 2013 distributes $2,500 each to four beneficiaries by March 15, 2014, those beneficiaries rather than the trust will report the income on their 2013 tax returns. (In fact, the trust does report the income and an equal deduction for the distribution. It provides each beneficiary with a K-1 form, which is like a 1099 from a bank reporting the income.)

Given these somewhat complicated issues, trustees and beneficiaries should contact an accountant or estate attorney with any questions about trust taxation.

Learn more about Massachusetts Estate Tax »

Topics: trusts

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