An Introduction to Trusts

trustsTrusts are not only for the ultra-rich in our society. Many other taxpayers can benefit from the tax shelter a trust can provide. A trust can minimize gift and estate taxes, and distribute income to beneficiaries, such as children and grandchildren. Business owners also can establish trusts that spell out how their business will continue to operate after their death. 

A trust is a legal entity separate from the person who sets it up. A trust can control the distribution of assets, perform legal transactions, pay bills, and file tax returns – with a little help from the person managing the trust, who is called a trustee. The trustee can be a person or an organization and is responsible for carrying out the wishes of the trust.

Assets need to be owned by the trust and are placed in the trust by a grantor, also known as donor, creator, or founder. The grantor determines the rules for the trust and decides how and when it will be distributed. The grantor and trustee can be the same individual. The organizations or people who receive assets or income from the trust are called beneficiaries.

A trust can earn income or incur expenses, which become the legal responsibility of the trust. In addition to ordinary income, sources of income can include interest, dividends, and capital gain. Expenses can include property taxes and administrative expenses related to managing the trust. Trusts report income and expenses on federal tax form 1041, U.S. Income Tax Return for Estates and Trusts.

There are many types of trusts, and they can be private or charitable. They can be created during a person’s lifetime (living trust) or after their death (testamentary trust) as specified in a Last Will & Testament (will). Living trusts can be revocable or irrevocable. Revocable means the grantor is able to change the terms of the trust at any time. In contrast, terms usually cannot be changed in an irrevocable trust without the beneficiary’s consent. Trusts can also be simple or complex. A simple trust is required to distribute income in the year it was earned, while complex trust can accumulate income and reinvest.

Each type of trust has pros and cons which could have a significant impact on tax liability for the trust and beneficiaries. It is best to speak with an estate planner to explore all options before making a decision. 

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