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Does A Revocable Trust Have To Pay Federal Income Tax?


Revocable trusts are the simplest form of trusts used in estate planning. A trust is a legal arrangement whereby a grantor transfers certain assets to a trustee, who then holds those assets for the benefit of certain beneficiaries. In the typical revocable trust, these are all the same person. That is to say, if you create a revocable trust during your lifetime, you can name yourself as trustee and continue to benefit from using any property placed in the trust.

So how does this work for tax purposes? Do you need to file a separate federal income tax return for the trust? (Florida, of course, has no state income tax.) And what happens after you die? If your successor trustee distributes the remaining trust assets to other beneficiaries, who pays any tax on that?

While you should always consult with a lawyer before making any decisions regarding trusts or taxation, here is a broad overview of how the law works in this area.

Revocable Trusts During the Settlor’s Lifetime

To continue with our simple example of a revocable trust where you are the grantor, this is basically what the Internal Revenue Service considers a disregarded entity. In plain terms, as long as you are alive and the trust remains revocable, the IRS acts as if the trust does not exist for income tax purposes. Any income generated by the trust’s assets must be reported on your individual Form 1040 each year. Indeed, you do not even have to obtain a separate tax identification number for the trust as it is not yet considered a legal entity as far as the IRS is concerned.

Revocable Trusts After the Settlor Dies

We say “not yet” because once the settlor of a revocable trust dies, things change. At this point, the revocable trust now becomes irrevocable. In other words, the original trust instrument can no longer be changed.

The trustee–usually a successor trustee designated by the original trust documents–must now obtain a separate tax identification number for the trust to distinguish it both from the deceased grantor as well as their probate estate, which is also a separate legal entity for tax purposes. If the trust continues to generate income, it must be recorded and reported on a separate return–an IRS Form 1041.

As for who pays any tax due, the short answer is that any distributions of income from the trust are paid by the beneficiary and not the trust itself. The principal is typically not taxed as the IRS will assume that money was already taxed before it was placed into the trust.

Again, this is a very simple overview of how taxes work with revocable trusts. If you have additional questions or would like to speak with a qualified St. Petersburg trust planning lawyer about this subject, contact Legacy Protection Lawyers, LLP, to schedule a consultation with a member of our estate planning team.

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