Most estate plans should include a trust. But before you create a trust, it is good to understand how that trust may affect your individual income taxes. There are different types of trusts, and each has its own tax consequences. Typically, the nature and extent of those consequences depends on who is responsible for paying the taxes on the income from the trust. So, if you are wondering: “will my income taxes change if I create a trust?” It depends.
What is a Grantor trust?
A trust is classified as a “grantor” trust if the grantor retains power over various aspects of the trust. The “grantor” is the individual who established the trust, either by grant or gift. As the grantor of a grantor trust, you will continue to pay the income taxes on any trust assets. This is because, for tax purposes, a grantor trust is considered a “disregarded entity.” That means the taxable income or deductions earned by the trust will be included on the grantor’s tax return. In this situation, it is generally not necessary to file a trust income tax return.
Grantor trusts are often used
If you already have a grantor trust, it is likely part of an effective estate planning strategy. There are different types of grantor trusts, as well. Some common types of grantor trust included in many estate plans are inter vivos revocable trusts, defective grantor trusts, retained annuity trusts, spouse access trusts and irrevocable life insurance trusts. Also, a dynasty trust can be structured so that it acts as a grantor trust.
The differences between grantor and non-grantor trusts
One, the difference between non-grantor and grantor trusts is who is responsible for paying the income taxes on the trust assets. With a non-grantor trust, the income tax is paid at the trust level. In other words, whenever a distribution is made from the trust to a beneficiary, the taxes on that income will be included on the beneficiary’s individual income tax return.
If you have questions regarding trusts and income taxes, or any other estate planning needs, please contact Sexton, Bailey Attorneys, PA online or by calling us at (479) 443-0062.