The Health Care and Education Reconciliation Act of 2010 imposes a Medicare contribution tax of 3.8% on unearned income of individuals, estates, and trusts. The net investment income tax applies to most trusts and estates beginning January 1, 2013. Trusts that are treated as business entities, certain state-law trusts, tax-exempt trusts, and grantor trusts are exempt from the tax.
The American Taxpayer Relief Act of 2012 also raised the maximum marginal tax rate on ordinary income and capital gains of trusts with taxable income exceeding $11,950 to 39.6% and 20%, respectively. (An individual beneficiary of a trust is not subject to these higher marginal tax brackets until his or her taxable income exceeds $450,000 for married filing jointly or $400,000 filing as a single individual.) Trustees may receive pressure from beneficiaries to make distributions to reduce or eliminate the tax and reduce the overall effective tax rate on trust income. Trustees need to remember to consider the maturity of the beneficiary, potential loss of creditor protection, potential exposure to future estate taxes, and risk of loss related to future divorce of a beneficiary.
The income tax expense of trusts and estates retaining taxable income at the trust level has increased significantly on net investment income. Fiduciaries must consider reconfiguring investments in light of after-tax returns on current holdings. Actions they might consider include investing in tax-exempt securities and adding a trust fiduciary that materially participates in trade or business activities held by the trust or pass-through entities it owns.BACK TO LIST