A Guide to Revocable Trust Taxes

Revocable Living Trust A Guide to Revocable Trust Taxes

Understanding Revocable Trust Taxes

One of the many myths that creators of living trusts mistakenly believe is that all living trusts save income taxes. In reality, there are different tax consequences for revocable and irrevocable taxes. In this article, we will clarify the tax treatments between revocable vs irrevocable living trusts.

Revocable vs Irrevocable Living Trust

A living trust is a legal document created by a grantor while he or she is alive. It is similar to a will that specifies the grantor’s wishes concerning assets and beneficiaries. However, it is different from a will in a way that the will becomes effective only after the grantor passes away and the will has entered probate. A living trust doesn't go through probate and automatically authorizes a successor trustee to manage your estate after death. Living trusts can be categorized into two types:

Revocable TrustIrrevocable Trust
Easy to amend or cancel at any time while the grantor is aliveHas more permanence and cannot be altered or revoked once confirmed 
Grantor continues to own and control assets in the trustControl of assets is relinquished to the trust
Assets in the trust can be removed or added at anytimeAssets that are “funded” into the trust must remain in the trust

Trust Taxation Based on the Type of Trust

Before deciding to create a living trust, make sure to have a strong understanding of the basic income tax rules. These will have long-term implications for your estate and your loved ones’ lives. Some of the concerns involved are where reporting of income taxes should happen and who pays for them. Here below are the trust taxation details that you need to take note of:

  • Revocable trust – A revocable trust has the simplest tax arrangement. Revocable trusts are considered grantor trusts and are not accounted for by the IRS and state taxing authorities. If the trust generates income, the tax will be levied on the grantor. The trust’s taxpayer identification number (TIN) will be the grantor’s social security number.
  • Irrevocable trust – Irrevocable trusts are required to have their own TINs. The income tax should be reported to the IRS using Form 1099 and Form 1041 for deductions and federal income tax purposes. Irrevocable trusts have two taxation categories: grantor and non-grantor trusts.

What Is Form 1041 for Revocable Living Trusts?

The official name for Form 1041 is US Income Tax Return for Estates and Trusts.  Although it is similar to Form 1040,  Form 1041 differs in a way that the filing entity is the trust. If the trust generates income, it needs to be reported on this form along with attorney fees, charitable contributions, and other deductions. Here are more pointers regarding Form 1041:

  • In a revocable living trust, you do not have to file Form 1041 while the grantor is still alive and still serving as the trustee. 
  • A revocable living trust’s income is reported on the grantor’s personal Form 1040 along with all interests, dividends, and others.
  • When the grantor passes away or becomes incapacitated, the revocable trust becomes irrevocable. At the same time, the trust needs to have an Employer Identification Number (EIN).
  • When the successor trustee takes over, he/she needs to acquire a separate tax ID number for the now-irrevocable trust.
  • A separate income tax return must be filed for the EIN using Form 1041 on the same date as filing a Form 1040.

Process for Filing a Tax Return

When the grantor dies or becomes incapacitated, a revocable trust changes and the rights of the assets in the trust are transferred to the beneficiaries. However, before that can happen, the trustee receives all the powers and rights that the grantor used to hold. The appointed trustee needs to file the irrevocable trust taxes through the below process:

  1. Obtain an irrevocable trust tax ID number, also known as federal tax ID or the EIN.
  2. Evaluate whether the income amount exceeds $600 in the tax year.
  3. Obtain Form 1041 for the trustee and Form 1065 for the beneficiaries. Make sure that Form 1065 (also known as Schedule K-1) is the correct version.
  4. Report all earned income by the property to the IRS.
  5. Report profits and losses.
  6. Add deductions.
  7. Fill out the form and send copies to the beneficiaries.
  8. Submit to the IRS.

Get Your Living Trust from DoNotPay!

Drafting a living trust is a complicated process that some cases require the expertise of a lawyer. Hiring an attorney to set up a living trust costs somewhere around $1,000 to $2,000 for individuals and upwards of $5,000 for joint living trusts. Those with smaller estates can take advantage of cheap online living trust forms. But, in some cases, the legal acceptability of the language may be questionable. That is where DoNotPay can help. Our robot lawyer helps users create living trusts without the high attorney fees:

  1. Sign-in to DoNotPay and select the Revocable Living Trust icon
  2. Enter the state where your document will be signed/notarized
  3. Enter the name and details of your trustees
  4. Enter the name of your beneficiaries
  5. Allocate your assets and properties

We can help you set up living trusts in the following states:

CaliforniaOhioHawaii
FloridaWisconsinMissouri
TexasVirginiaPennsylvania
ArizonaNorth CarolinaUtah
MichiganGeorgiaIndiana
ColoradoMassachusettsIdaho
IllinoisMarylandSouth Carolina
Washington StateNew JerseyLouisiana
OregonMinnesotaAlaska
New YorkOklahoma

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