Just like a person, a trust must file a tax return and pay taxes. However, unlike a personal tax return, a trust tax return can become very complicated. Often a person will not even realize that an income tax return has to be filed for a trust. It is not uncommon for a self-prepared trust return to be incorrect. Either way the trust will end up paying much more in taxes then is required.
Types of Trusts For Income Tax Purposes
For income tax purposes a trust is generally classified either as a ‘simple' trust or a ‘complex' trust. There are a variety of other classifications but for purposes of this article we will focus on these two types of trusts.
A ‘Simple Trust' is a trust that is required to distribute all of its income currently for the taxable year and does not provide that any amounts be paid, permanently set aside or used in the taxable year for charitable purposes and does not make any distributions other than of current income.[1]
A ‘Complex Trust' is a trust that does not meet all of the criteria listed above for a ‘Simple trust'. It should be noted however that this designation between Simple Trust and Complex Trust can change from year to year.
Trust Tax Rates
The tax rates for a trust go up much quicker than those for an individual. In 2022, the first $2,750 in trust income is taxed at 10% and then trust income of $2,751 to $9,850 is taxed at 24%; trust income of $9,851 to $13,450 is taxed at 35% and any trust income over $13,451 is taxed at 37%. So, if a trust had taxable income of $14,000 it would pay $3,442 in taxes to the IRS. However, if an individual had taxable income of $14,000 then they would only pay $1,474 in taxes.
Trust Income
A trust will have to report as income on the tax return such items as dividends, interest, capital gains, rental income and basically any other type of income that is earned by the trust. Often a trust will be the owner of a brokerage account that generates dividends or capital gains or the trust might own a rental property or even a business.
Deductions on Tax Return
Some of the most common types of expenses that a trust can deduct on its tax return include fiduciary fees. Fiduciary fees include probate court costs, fiduciary bond expenses, or trustee fees. Professional fees such as accounting fees or legal fees can also be deducted on the tax return. Under I.R.C. Section 67(e) sets forth what other costs that are paid by the trust or estate maybe deducted on the tax return.
Need Copy of Trust Agreement
To accurately file a trust tax return you should have a copy of the actual trust document. This is necessary so that you can determine whether the trust is a ‘Simple' or ‘Complex' Trust and whether capital gains are to be distributed to the beneficiaries or retained in the trust.
Due Date of Returns
A trust tax return is due by the 15th day of the 4th month following the close of the tax year. So with a calendar tax year that ends on December 31st, the return would be due April 15th.
If you are the trustee of a trust, you almost have to treat it as running a small business and you must understand your tax filing requirements. A trustee should have a trust tax return prepared by an experienced tax professional.
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[1] 26 CFR Section 1.651(a)-1
