Trusts 101

Trusts 101

Authored by Haynie & Company Partner Bernard Abercrombie, CPA


Every year we receive questions from clients about whether they should set up one or more trusts. The first question we must ask is why they think they need a trust. The answers usually fall in a few categories such as asset protection or estate planning. Sometimes there are perceived benefits of income tax savings or college education funding. Generally, these last two do not produce the intended results and the concept is dismissed when details about how trusts work are spelled out.


The area of trusts and trust taxation are quite complex and exceed the scope of this article, so we will merely focus on the basics of Simple Trusts and Complex Trusts and a brief overview of when they are created and why. There are several other types of trusts such as Charitable Trusts, Defective Grantor Trusts, Special Needs Trusts and more that we deal with regularly. These usually relate to specific estate planning techniques that require an in-depth analysis and explanation to determine their applicability.


First, we will talk about Revocable Trusts, which mean the Grantor of the Trust can revoke them at any time. One of the most common type is in the form of a Revocable Living Trust. In their basic format, these are for the most part ignored for income tax purposes, assets stay inside the Grantors estate, and it is as they don’t exist for tax purposes. There are many legal reasons why these are utilized such as avoiding probate, handling out of state properties, etc.


Next are Irrevocable Trusts that file a tax return of their own and have their own Federal ID Number. The basic Irrevocable Trusts come in two forms, a Simple Trust, and a Complex Trust. Simple Trusts require the distribution of all income during the year to the beneficiary and generally prohibit distribution of principal or charitable donations. A Simple trust can be Simple in one year and Complex in another.

If a trust is not a Simple Trust, then it is a Complex Trust. A Complex Trust is allowed to accumulate income and distribute principal. Unlike A Simple Trust that can be a Simple Trust in one year and a Complex Trust in another, a trust set up as a Complex Trust cannot be a Simple Trust.

One significant factor of a Complex Trust is its taxation. Trust income is calculated net of allowable deductions and the remainder is taxed at the trust level. One of the items allowable is a deduction for amounts distributed to beneficiaries. Trust tax rates reach very high tax rates at low-income levels, creating unanticipated taxation that could have been reduced by distributions during the year or within 65 days after year end under a special rule to beneficiaries. The beneficiaries receiving the distributions then include that income in their personal returns. We tell clients to look at the logic of whomever has the money, pays the tax. Capital gains are generally not allowed as part of the distribution deduction and are taxed at the trust level. Exceptions are sometimes available if state law and the trust document allow it.

As I indicated trust taxation can be very technical. As always, please consult your Haynie CPA for specific details of your situation.

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