Trusts are invaluable tools in estate planning when it comes to securing your financial future and ensuring that your assets are handled according to your wishes. However, the intricacies of trusts and their tax implications can feel like deciphering a complex legal code. Fear not; we’re here to demystify trusts and shed light on what your estate planning attorney wishes you knew. This article outlines trust terms, types of trusts for estate planning, and tax implications for 2023 and 2024.

Trust Terms: Understanding the Basics

Trusts are based on three elements:

  1. The legal document for the grantor/creator who funds the trust or transfers their assets;
  2. The trustee named to administer or manage the trust according to the terms; and
  3. The beneficiaries to receive the assets once the grantor is gone.

Trusts differ based upon how these elements are managed and interact through the trust terms. The legal document that is the trust can be revocable or irrevocable. Revocable trusts are flexible and allow easy changes or cancellations. Irrevocable trusts are not easily changed or revoked but are most often used to exclude assets from an individual’s estate and protect assets from potential creditors. The trust’s grantor, trustee, and beneficiary can all be the same person and usually are during the lifetime of the grantor, especially with a revocable trust. The grantor’s death will often trigger changes within the trust based upon the trust terms. For instance, a revocable trust becomes irrevocable upon the grantor’s death. If the grantor was the trustee prior to death, a new trustee will take over based upon the trust terms. If the grantor was the beneficiary, new beneficiaries will arise and will receive distributions depending upon the trust terms.

Trusts are very important to a holistic estate plan. They can serve different purposes, from holding college funds to keeping a beloved home in the family for generations, and their most common use which is to avoid probate court. How you structure the trust terms and who you choose as trustee will depend upon the purpose of the trust and the needs of the beneficiaries.

The assets in the trust are defined  as the trust’s “principal” and any earnings from that principal, whether it’s dividends, interest, rent or something else, is defined as the trust’s “income.” The trust’s principal assets generally include real estate, investments, cars, bank account funds and personal property like jewelry.

How Trusts are Taxed is based upon the Trust Terms

The IRS has different classifications for trusts based upon how they are taxed and what is distributed from income and principal. These classifications, and further information on how trusts are taxed, is outlined in SmartAsset’s article, “Trust Tax Rates and Exemptions for 2023 and 2024” and summarized below.

Trust Classifications

  1. Grantor Trust – With the grantor maintaining control, this trust has all income taxed to the grantor and reported on their individual taxes, or in the case of a joint trust for a husband and wife their joint taxes. The other two types of trust, simple and complex, pay taxes directly and report to the IRS separately from the grantor.
  2. Simple Trust – This straightforward trust model holds income-producing assets. All income is distributed to beneficiaries without tapping into the principal. The one caveat with a simple trust is income distribution must occur at least once a year (annually).
  3. Complex Trust – Offering more flexibility, a complex trust may retain some income, can distribute principal, and can allocate funds to charitable causes in addition to other beneficiaries.

Trust Taxes

Trusts are not immune to paying taxes and what taxes the trust pays on its income depends upon the classification of the trust itself and the classification of the income into either ordinary or long-term capital gains.

A grantor trust will be taxed based upon the income tax bracket of the grantor. Here is a glimpse at the tax brackets for simple and complex trusts for both 2023 and 2024:

  • 2023 tax brackets range from 10% to 37% for ordinary income and from 0% to 20% for long-term capital gains.
  • 2024 keeps the percentages the same but makes slight adjustments to the tax brackets used for ordinary income to determine the applicable percentages.

Understanding these tax nuances can empower you to make informed decisions regarding your trust’s financial management. Working with an estate planning attorney can help you implement the trust that best fits your intentions. Need help understanding all of this? Book a call with one of our experienced estate planning attorneys in St. Louis, Missouri.

Key Takeaways:

  • Trust Basics: Trusts consist of a grantor, trustee, and beneficiary.
  • Trusts and Taxes: Trust income is subject to taxation, with rates varying based on the type of income, type of trust, and the tax year.
  • Types of Trusts: The most basic types of trusts are revocable and irrevocable, which can be classified as either simple, complex or grantor.
  • Trust Creation: A seasoned estate lawyer can provide invaluable guidance, ensuring that your trust aligns with your long-term financial goals.

Conclusion

Understanding all of this can be daunting. However, you don’t have to navigate these waters alone. Seek the guidance of a trusted estate planning lawyer to chart a course that safeguards your assets and secures your financial legacy for generations to come. Book a call with an attorney at Frankel, Rubin, Klein, Payne & Pudlowski to get started today.

Reference: SmartAsset (Jan. 5, 2024) “Trust Tax Rates and Exemptions for 2023 and 2024.”