Myths on Trust Taxation

02-11-2017Tax Information

I periodically get inquiries from individuals who think they can avoid income taxes because they have a trust.  Trusts are often very good tools to protect your assets; but not always a good tool for simple tax planning strategies.  Trusts generally have much lower deductions, compressed marginal tax rates, and a much lower threshold for the net investment income tax.  Thus, a trust may incur higher income taxes than an individual may pay.

Here are some tax considerations when evaluating a trust.

In most cases, estate and non-grantor trust income pays taxes like an individual, with the following main differences:

  • Trusts and estates (other than bankruptcy estates) do not get a standard deduction.
  • These trusts and estates get an exemption, but only $100, $300, or $600
  • Trusts and estates do get a deduction for trust income distributed to the beneficiaries, which is computed based on the actual distribution amount, distributable net income (DNI), and net accounting income
  • Trusts and estates do have the same progressive tax rates as individuals, with the exception of the lowest 10% rate bracket, which exists only for individual taxpayers. However, compared with those of individual taxpayers, the tax brackets are very compressed, with the highest marginal tax rate of 39.6% starting at $12,500 in taxable income for 2017.
  • Complex trusts and estates do not have a limitation for charitable contribution deductions from gross income.
  • Simple trusts cannot make charitable contributions
  • The net investment income tax applies to trusts and estates based on a threshold at the highest tax bracket and not on a fixed dollar amount.
  • The top rate of 20% for net long-term capital gains and qualified dividends applies when income reaches the top marginal bracket for ordinary income of 39.6%; due to the relatively compressed brackets, this means the 20% rate goes into effect if taxable income of trusts and estates exceeds $12,500 in 2017.
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