An irrevocable trust puts your assets in a protective place until they can be handed off to survivors after your death. After they’re put in the trust, those funds can’t be touched, which means you give up all rights to your assets once they’re in an irrevocable trust. The good news about irrevocable trusts is that they remove you from tax liability on the money you put in there. However, once you’ve died, the estate will be liable for paying taxes on the income that money generated.
Irrevocable Trust Tax Return
An irrevocable trust becomes a separate tax entity, which means a tax return will be submitted on behalf of that trust. The trustee, appointed by the estate, handles making sure that tax return is filed, which starts with applying for a tax ID number. The trustee will report estate taxes using Form 1041, U.S. Income Tax Return for Estates and Trusts. On this form, you’ll disclose any interest income, deductions, gains and losses for the trust. You’ll also report any distributions on this form.
You’ll only need to complete and submit Form 1041 if the estate generates more than $600 in gross income for the tax year. You’ll figure the income similarly to the way you’d calculate income for an individual. However, when you distribute money to beneficiaries, you’ll also need to deduct those distributions and report them using Schedule K-1. When you file depends on whether yours is a calendar year trust or a fiscal year trust. Calendar year trust tax returns must be filed by April 15 of the year following the grantor’s death. Fiscal year trusts are filed by the 15th day of the fourth month after the close of the tax year. If necessary, you can file an extension as you would an individual tax return.
Setting Up a Tax ID
The first thing a trustee will need to do, tax-wise, is set up an irrevocable trust tax ID number with the IRS. This requires applying for an Employer Identification Number, which can be done online for free in a matter of minutes. You can apply through the IRS Monday through Friday from 7 a.m. to 10 p.m. Eastern Standard Time. You can also apply by fax or mail if you prefer, but the approval process will take longer.
If you apply for your irrevocable trust tax ID number online, the application will walk you through the steps of getting a number for an estate. You’ll choose estate under “What type of legal structure is applying for an EIN?” and then input the requested information about the deceased. You’ll be issued a nine-digit number that will stay with the trust while all the funds are distributed.
At some point, the money in the trust will be distributed to survivors under the terms stipulated by the grantor. When this happens, those receiving the distributions will pay taxes on the income-earning portion of the money they receive. Tax laws are set up to avoid double taxation, so this means that the estate can take a deduction on that taxable income when it’s distributed. It’s important to note that while the income on the trust is taxable, the principal is not.
Each beneficiary will receive a Schedule K-1, which will detail the amount paid, as well as the income and losses on the trust. They’ll report the income on their Form 1040, Schedule E, Part III. They won’t need to send a copy of Schedule K-1 in with their tax return. The way you report this income should match what the trust turned in on its tax form. If there are discrepancies, you may need to straighten it out with the trustee. If it still differs, you’ll need to complete Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request.
Taxes on Revocable Trust
If you have a revocable trust, the process is a bit different. Unlike irrevocable trusts, revocable trusts can be changed, which means you can add to or even revoke the trust at any time. You’ll also be able to receive any income you earn on the principal. For this reason, you’ll be expected to pay taxes on that income on your own tax return while you’re still alive.
Upon your death, though, the trust becomes its own entity. You’ll need to create an EIN and file separately, just as you would with an irrevocable trust tax return. If the trust earned income in its final year, the trustee will file that with your own individual tax return for that year, then begin paying taxes as the estate for subsequent tax years. When distributions are made, those are claimed as deductions on the estate’s tax return, just as would happen with an irrevocable trust.
There is good news for those who owe taxes on trusts, though. The Tax Cuts and Jobs Act dropped the trust tax brackets from its 2017 numbers. Beneficiaries who owe less than $2,550 will pay only 10 percent, down from 15 percent in 2017. Things get more complicated if the trust earns more than $2,550 in income since it’s a set rate plus a percentage. From $2,551 to $9,150, you’ll pay $255 plus 24 percent of the amount above $2,550. From $9,151 to $12,500, you’ll pay $1,839 plus 35 percent of the amount over $9,150, and if your trust earned more than $12,500 in income, the tax will be $3,011.50 plus 37 percent of the excess above $12,500.
One thing that can be confusing about trust tax brackets is that some trusts follow a fiscal tax year. This means some of your earnings could have fallen in 2017, when rates were higher. In some instances, the IRS requires taxpayers to use a blended 2017 and 2018 tax rate, but not in this one. There is no requirement to use a blended rate with your trust tax this time. You can file your taxes using the 2018 brackets.
Closing an Irrevocable Trust
At some point, an irrevocable trust must come to an end. Usually, this happens once all the property in that trust has been distributed, which leaves nothing in the trust. But trusts may end simply because the grantor specified an end date. Whatever the case, the trustee must pay close attention to whether or not it’s necessary to file an irrevocable trust tax return until the date the trust can be officially seen as reaching an end. Because of this, the end of the trust can be a relief, since it means not having to deal with the paperwork every year.
Once all the assets in the trust have been distributed and it’s empty, you’ll then file a final return using the current trust tax brackets. This is only applicable if the trust had $600 or more in income during that final year. You should also notify each beneficiary in writing, including a final accounting of the trust. In some areas, this written notification and accounting is required by law, so check into this before you send it to make sure you cover all your bases. You won’t need to notify the IRS that your trust is no longer effective. There’s no process in place to cancel an EIN, so it will just remain open indefinitely.
- IRREVOCABLE | definition in the Cambridge English Dictionary
- IRS: Deceased Taxpayers – Filing the Estate Income Tax Return, Form 1041
- IRS: How to Apply for an EIN
- IRS: Employer ID Numbers
- ThisMatter: Taxation of Trusts and their Beneficiari
- IRS: 2017 Partner's Instructions for Schedule K-1 (Form 1065)
- Elder Law Firm: Who Pays Income Taxes on a Revocable Living Trust?
- EideBailly: Tax Reform: Trust and Estate Key Rate Changes
- FindLaw: How Does a Trust End?
- AllLaw: Terminating (Closing) a Living Trust
- IRS: Canceling an EIN - Closing Your Account
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.