Minimizing taxes is an important part of effective estate planning. Different types of trusts can affect the taxes you, your estate or your heirs must pay in different ways.
What are the different types of trusts and how do they affect taxes?
A grantor trust gives the grantor specific powers over the trust and the grantor pays the taxes. Grantors do not need to file a trust income tax return. They can report it through their Social Security number instead. Beneficiaries receive money from the trust as a tax-free gift because they do not have to pay income taxes on the assets they receive.
Grantors do not have power over non-grantor trusts. Non-grantor trusts pay income tax on any income that the assets in the trust generate. Beneficiaries of a non-grantor trust must pay taxes on distributed assets as normal income tax. However, if the beneficiary is in a lower income bracket than the grantor, the tax rate on the assets that the beneficiary receives from the trust may be lower than what the grantor would have paid.
A non-grantor trust has a tax identification number and the grantor must file taxes for it. However, the trust is a separate taxable entity from the grantor, which may have tax benefits for some grantors who are business owners or have large estates.
There are many factors to consider when choosing whether to use a trust and what type of trust to use. The impact your choice has on your taxes and the taxes your heirs may pay is an important factor to consider.