A living trust, also known as an "inter vivos" trust, is a trust established while the grantor (trust creator) is still alive. Living trusts may be revocable or irrevocable, and may serve a variety of purposes. The IRS makes tax determinations based on the amount of control the grantor maintains over assets deposited to the trust.
Definition of Terms
A revocable trust is one that can be modified or changed at any occasion during the grantor's lifetime. This is the most common type of living trust. Irrevocable trusts cannot be changed or repealed. A revocable trust becomes irrevocable upon the death of the grantor.
The IRS uses the term "grantor" trust when discussing tax obligations. A grantor trust is any trust in which the creator (the grantor) maintains control of the assets within the trust. Grantor trusts are usually revocable, but they may be irrevocable in certain cases.
General Tax Obligation of Trusts
All trusts are required to file taxes if their annual income exceeds $600. Trusts typically pay tax at both the federal and state levels. Income calculations and deductions are very similar to those for individuals. Trusts do not typically take deductions for charitable donations, and may be taxed at different rates than individuals.
If a grantor maintains control over the assets of a trust (nearly all revocable trusts and a few irrevocable trusts), he may include the trust assets in his IRS Form 1040 and is obligated to pay the entire tax liability.
Trusts that do not qualify as grantor trusts are usually known as "simple" or "complex" trusts for tax purposes. Simple trusts are not grantor trusts and are required to distribute all trust income annually. "Complex" is a catch-all term for trusts that are neither grantor nor simple. These trusts are considered separate legal entities from their grantors, and are taxed individually. Holders of non-grantor trusts file IRS Form 1041, and may also be required to distribute form K-1 to beneficiaries who have taken a distribution during the taxable period.
Estimated Income Tax
Trusts usually need to pay estimated income tax on a quarterly basis if they expect that they will owe tax at the end of the year.
Taxes Owed by Grantors and Beneficiaries
In some cases, funds deposited to a trust are subject to the federal gift tax and may be taxable to the grantor.
Beneficiaries may be liable for any distributions they receive from the trust. The trust will generate a Schedule K-1 for any distributions paid throughout the year, and this amount must match the beneficiary's tax return.