According to the Missouri Bar, a trust is an agreement that states how a person's property and money are to be distributed during his or her lifetime, or after the person dies. A beneficiary who receives a distribution of money from a revocable trust generally must pay income taxes on that money, but it really depends on the circumstances. If the trust already paid income tax on the money, then you may not have to pay a second tax on that same money. But, if the trust did not pay income taxes, then you will have to pay the taxes.
No Double Taxation
Trusts can operate in one of two different ways. The trustee, who owns title of the trust and distributes the money according to the trust agreement, can either retain all income in the trust, pay taxes on the income and then make distributions tax free. Or, the trustee can immediately transfer all annual income produced by the trust to the beneficiaries so that beneficiaries pay the income taxes rather than the trust. A key principle under both scenarios is that the IRS does not double-tax any trust income. Either the trust pays the taxes, or the beneficiary pays the taxes, but not both.
The trustee should deliver to you, each year that you are a trust beneficiary, an IRS Schedule K-1. The Schedule K-1 lists each trust disbursement made to you during the year, and also lists whether that disbursement was taxed to the trust or must be reported as taxable income by you.
Sometimes, a trust may authorize a payment to you in one tax year, but you will not actually receive the money until the next tax year. For example, the trustee may authorize a payment to you on December 28 of year one, but you don't receive the money until sometime in January of the next year. You will have to pay taxes on your year one tax return even though you didn't actually receive the money until the next year. The guiding rule is that you pay taxes during the year that you acquired the right to receive the money, which may not be the same year in which you actually received the money.
A Schedule K-1 can show you both income that you must report, as well as deductions or credits that you may be able to claim in order to reduce your income tax liability. If the trust is entitled to claim a tax deduction or credit, but the trust does not pay any income taxes, then the beneficiaries have the right to claim those unused tax deductions and credits. This makes sense because if the beneficiaries are the ones who must report the income, then they should also be the ones who can claim the applicable tax deductions and credits. Again, all of this will appear on your Schedule K-1 that you receive each year from the trustee.
- "Estate Planning Basics;" Denis Clifford; 2009
- IRS: Publication 17 -- Other Income
- Internal Revenue Service. "Instructions for Schedule K-1 (Form 1041) for a Beneficiary Filing Form 1040," Page 2. Accessed Oct. 25, 2019.
The Constitution Guru has worked as a writer and editor for "BYU Law Review" and "BYU Journal of Public Law." He is an experienced attorney with a law degree and a B.A. degree in history with an emphasis on U.S. Constitutional history, both earned at Brigham Young University.