Tax Implications for Trust Distributions
A trust is a legal entity that a grantor creates for a beneficiary to serve as a source of income for the beneficiary, who may too young or, in some cases, too infirm to manage finances. Beneficiaries of trusts must pay federal and state income tax, when applicable, on the funds they receive.
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Trust Taxation
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A trust is like a corporation in that it constitutes a legal entity separate from any particular individual. For this reason, it must file its own income taxes, regardless of whatever taxable income the grantor, trustee or beneficiary receives. One special aspect of a trust's taxation is the fact that it can count the distributions it makes to the beneficiary as deductions when it files its tax returns.
Beneficiary Taxation
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When a beneficiary receives a distribution from a trust, that distribution becomes taxable income for him. Since the trust itself counts the distribution as a tax deduction, the government does not levy a double tax on it. As with other forms of income, the federal government decides the tax rate of trust distributions based on the individual's total taxable earnings for the year.
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Tax Filing
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Individuals reporting taxable earnings for a particular period must file a Form 1040 with the Internal Revenue Service. Beneficiaries of trusts must list trust distributions for the given period under Line 17 of this form. When trusts file their tax returns, however, they do not file a Form 1040; they file a Form 1041, which is entitled U.S. Income Tax Return for Estates and Trusts. On this form, they should list all of their income streams and applicable deductions.
Allowable Deductions
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When they file their tax returns, trusts may count taxes paid, legal fees and business expenses as deductions along with the distribution itself. When beneficiaries file their tax returns, they may count expenses that relate directly to the reception of the trust distribution as deductions as well, such as out-of-pocket legal fees.
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