Byron worked a long & successful career as the head of a local engineering firm. He built up the business over many years & provided the best for his family. However, he knows he is not getting any younger. Questions of how his children will inherit his wealth pass through his mind.
For Byron and other business owners who have amassed wealth, they know that it cannot follow them to the next life. Setting up an estate or trust is the most reliable and common option to efficiently transfer wealth to descendants.
Trusts & estates are fiduciary entities that distribute assets to beneficiaries. Individuals and families will often set up trusts to distribute assets to their descendants, or the totality of the assets of a recently deceased individual are combined to form their estate. Just like many other legal entities, trusts & estates are subject to income taxes. What are the differences between an estate and a trust? There are several, but for the purposes of brevity, we will take a cursory look.
Trusts & Estates Snapshot
In simplest terms, trusts & estates have these elements:
- Grantors set the parameters of the fiduciary entity, such as assigning beneficiaries, contributing assets like cash or property, and selecting a fiduciary to administer the entity.
- The fiduciary is responsible for administering the trust and/or estate. Fiduciaries can be individuals or organizations such as a bank or trust company.
- Beneficiaries receive the assets from the trust and/or estate.
Trusts may operate indefinitely, even after the grantor’s death, depending upon the terms surrounding the founding of that trust. Estates exist until all assets are distributed to the beneficiaries. Several types of trusts & estates exist, depending on the agreements in place by the grantor. Examples include revocable trusts and charitable remainder trusts.
Trusts, Estates, & Income Taxes
Income taxes occur on a fiduciary entity based on the income it earns or receives, expenses paid by the entity, and the distributions made to its beneficiaries. For example, the interest income an estate earns from the stocks held in the estate are taxable. The assigned fiduciary is responsible for filing regular income tax returns (Form 1041) and paying the related income taxes. Beneficiaries may also be liable for any income taxes connected to distributions from trusts and estates, depending on the nature of the distribution. Additionally, large estate and trust distributions may trigger additional estate tax & gift tax issues.
Identifying where income tax issues may occur for an estate or trust need a level of specialization to analyze. Unfortunately, not all accounting firms may have the bandwidth for it. However, we at MiklosCPA have the knowledge and experience in successfully handling the complex tax issues that can arise with unique cases like trusts & estates. Grantors, fiduciaries, and beneficiaries that may be interested in learning how we can help should consider giving us a call. Additionally, follow us on our social media pages for more useful tax tidbits & other business good reads.