Taxes on a Disbursement From a Trust
Setting up a trust is an effective estate planning tool that can help your family avoid probate and potentially estate taxes. When a beneficiary receives money from a trust, a portion of it may be taxable, depending on the situation. The size of the estate and how the money was generated will play a role in determining its tax status.
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Estate Taxes
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If the money is distributed to a beneficiary after the death of the person who set up the trust, estate taxes may apply. Estate taxes are charged on estates that are above a certain value. As of 2011, the estate will only be subject to estate taxes if it is worth more than $5 million. If the trust is a revocable trust, the assets within it are still considered part of the estate. If the trust is an irrevocable trust, the assets will not count toward the estate tax exemption. The money for estate taxes will be taken out before you receive your disbursement from the trust.
Investment Earnings
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Some trust funds are set up to distribute money to beneficiaries before the death of the trust grantor. The trusts have investments in them that generate income on a regular basis. If the income from the investments is distributed to the beneficiary before taxes are paid on it, the beneficiary is responsible for the taxes on the earnings. The taxes could be based on capital gains tax rates or they could be taxed at marginal tax rates, depending on what investments generated the earnings.
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Inheritance Taxes
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Although the federal government does not charge any inheritance taxes, some state governments do charge inheritance taxes. If you live in a state that has an inheritance tax, you may have to pay taxes on some of the money you receive from a trust. If the grantor of the trust dies and you receive your inheritance from the trust, the total value of your inheritance is taxable. Unlike estate taxes, inheritance taxes are paid by the person who receives the money.
Avoiding Tax
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If the person who sets up the trust does it correctly, you may not have to pay any taxes on the money that you inherit. If the total size of the estate is less than $5 million, no estate taxes will be levied. If you live in a state that does not have inheritance taxes, you will not have to pay any inheritance taxes. If the assets in the trust do not generate income or if the taxes are paid while in the trust, you should not have any income taxes to pay.
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