Tax on Trust Disbursements
Trusts are legal entities that can hold title to assets or property for the benefit of a person, group or organization. Whoever receives income from a trust or is intended to eventually receive income from a trust is referred to as a "beneficiary." When a trust issues a disbursement, both the beneficiary of the trust and the trust itself have specific tax obligations.
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Trust Obligations
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When a trust issues a disbursement, it must provide each beneficiary with a Form K-1, which documents the amount of money transferred to the beneficiary or the beneficiary's guardian, if the beneficiary is a minor. The trustee must also furnish a copy of the Form K-1 to the Internal Revenue Service.
Trust Tax Returns
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Like individuals and corporations, the trust also must file an income tax return each year, using IRS Form 1041. The disbursement itself is a tax deduction for the trust on Schedule B of the Form 1041. The trust itself must pay income taxes of up to 35 percent (as of 2011) on any income it receives that it does not disburse to beneficiaries.
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Tax Obligations of Beneficiaries
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Income received from a trust is taxable to individuals as ordinary income tax. If you receive a K-1 from a trust, you must record the amount distributed to you as noted on the K-1 on your individual income tax return.
Considerations
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The tax code is designed to encourage trusts to disburse income to beneficiaries, rather than let funds accumulate in the trust. The income tax brackets for trusts are much narrower than brackets for individuals, and trusts do not receive a standard deduction unlike individuals. Trusts therefore pay higher taxes on their income than individuals do. The faster the trustees can get income out of the trust and passed on to beneficiaries, the lower the net taxation will be.
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