Page 59 - Successor Trustee Handbook
P. 59

When each beneficiary’s individual Trust is setup (usually at the end of the initial Trust
          administration), each individual Trust will require a taxpayer identification number and
          tax return. When we speak about tax returns, keep in mind that there will not only be
          Federal income tax returns (Form 1041), but also, depending on the legal location of the
          Trust (or Trust “situs”, which your attorney and accountant will need to determine), there
          may also be a state income tax return due. Some states do not have an income tax, but
          may  have  another  tax  for  which  the  Trust  may  be  required  to  file  a  return,  such  an
          “intangible property” tax.




           Whether or not a Trust will actually pay any income taxes basically depends on whether
          the Trust or the beneficiaries of the Trust end up with the trust income by the end of the
          Trust year (plus a 65-day grace period after the end of the tax year). In other words, the
          Trust will be required to file income tax returns, but if a Trust distributes its potentially
          taxable income through this period, the beneficiaries will report the income they have
          received  on  their  own  personal  income  tax  returns,  and  they  will  be  responsible  for
          paying the taxes.   Since individuals are usually in a lower income tax bracket than a
          trust,  you  should  consult  with  your  accountant  toward  the  end  of  each  tax  year  to
          determine  whether  distributions  to  beneficiaries  should  be  made  (if  the  Trust  terms
          permit  and  in  what  amounts).  However,  you  cannot  always  let  the  “tax  tail  wag  the
          dog” and may want to pay higher income taxes at the Trust level, rather than distribute
          to  a  beneficiary  who  may  squander  the  money  or  use  it  for  less  than  worthwhile
          purposes, or lose the protection that the Trust may be able to afford him or her against
          a spouse in a divorce, creditors, lawsuits, and loss of government needs-based benefits;
          therefore, the question of whether to make distributions to beneficiaries may also be
          one to run by your attorney.


          Upon the death of the first spouse of a married couple, assuming that “A, B and C”
          Trusts are to be established, you will need to review with your attorney the effect that
          allocation  of  certain  assets  to  each  of  these  new  Trusts  will  have  in  the  future  for
          income tax purposes. For example, if the surviving spouse’s residence is allocated to
          the A Trust, then if that property is later sold within his or her lifetime, he or she may be
          able to fully utilize the federal capital gains exclusion (currently $250,000); however,
          this exclusion is not available to the B and C Trusts. Assets allocated to the A and C
          Trusts will be allowed a “step-up” in their income tax basis to the fair market value of
          those assets at the date of the death of the second spouse; this will effectively allow
          depreciable  properties  like  real  estate  to  generate  greater  tax  deductions,  and  will
          reduce potential capital gains taxes when those A and C assets are later sold. Again,
          you cannot let the income “tax tail wag the dog”, as there may be very sound estate
          tax  and  other  reasons  for  allocating  the  home  to  the  B  and  C  Trusts  and  the  other
          growth-oriented assets to the B Trust. These are issues you will need to review with your
          attorney at the time that the allocation of assets to the A, B and C are made.  (See
          also, Chapter 15, “Estate Taxes”).









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