Tax Consequences for Trust Beneficiaries
A trust is a legal relationship in which an individual transfers his assets to an individual or company that manages the assets for the benefits of designated people. A person can establish a trust that operates while he is still alive or one that will disburse money after his death. Before setting up a trust, be aware of the tax consequences for the beneficiaries.
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Gift Tax
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Beneficiaries of a trust may have to pay the gift tax, which applies to the transfer of any property from one individual to another. The Internal Revenue Service defines "gift" as something for which the giver receives nothing in return; if the giver does receive something, the value of what was received does not equal the full value of the gift. Even if the grantor of the trust does not intend to give his beneficiaries a gift, the Internal Revenue Service looks at the end result and taxes the recipient accordingly.
Income Tax
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The beneficiary might have to pay income tax on the money received through the trust, depending on what type of trust was set up. In a simple trust, the income generated passes to the beneficiary. The IRS treats this type of trust as an income generator for the beneficiary and requires that the recipient pay income taxes on the money collected from it.
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Estate Tax
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A trust can accrue estate taxes, which the IRS levies on the right to transfer property after a person's death. Trusts count as part an individual's property. However, most people will not have to pay this tax. Only gifts that exceed $1 million require payment of estate tax. As long as your trust does not reach that amount, you will not be affected.
Generation-Skipping Transfer Tax
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People sometimes set up trusts that disburse money not to their children but to their grandchildren or great-grandchildren. The IRS calls this type of trust a generation-skipping trust. To ensure that it obtains revenue from the trust, the IRS levies a tax, known as the generation-skipping transfer tax. Up to $3.5 million from this type of trust is exempt, so most people will not have to pay the tax.
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