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Ask the expert: Irrevocable trust’s terms determine tax picture

I’m the trustee of an irrevocable trust. Does the trust have to pay state and/or federal taxes? If so, what tax forms are used? I have no definitive answer because the lawyer, financial firm and tax adviser all say to ask each other.

Financial firms aren’t in the business of giving tax advice, but your attorney and your accountant should know to look for the answer to your question in the trust document.

In simple trusts, the trustee typically is required to distribute all “fiduciary” income — i.e., interest and dividends — to trust beneficiaries at least annually, says Alan E. Weiner, a Melville tax professional. (Capital gains are rarely distributed from a trust.)

If the trust has less than $300 of annual fiduciary income, it has no tax filing obligations.

If its income is more than $300, the trust must file a fiduciary income tax return (Form 1041) and a New York State income tax return (Form IT-205), even if it owes no taxes because all its income has been distributed to the beneficiaries. The trustee should attach a Form K1 to the trust’s federal and state returns, says Weiner. “The K1 lists the beneficiaries’ addresses and Social Security numbers. A copy of the K1 also goes to each beneficiary. It tells them what income they’ll need to report on their own tax returns.”

If the trustee has discretion to decide how much income to distribute every year and he doesn’t distribute it all, the trust must pay taxes on income not distributed to the beneficiaries. That quickly becomes expensive. A trust pays a 39.6 percent federal tax on annual income exceeding $12,500, notes Weiner. By contrast, an individual’s income isn’t taxed at 39.6 percent until it exceeds $413,201.

THE BOTTOM LINE A trust document determines the trust’s tax obligations.


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