A living trust is often used in families where many assets need to transfer upon death. The living trust keeps assets out of probate and allows them to transfer more quickly. While the person is still alive, she controls the living trust and there are tax and reporting requirements that must be followed.
What Is a Living Trust?
A living trust is a separate legal entity that holds the assets of the trust owner, called the grantor. Upon the death of the grantor, the assets in the trust are disbursed according to the trust documents. The benefit of transferring estate assets this way is that it does not require the assets to be probated by a court. This hastens the transfer process. Another benefit is that the terms of a living trust are private unlike a will and a probate proceeding that are public record. A living trust prevents public dissemination of who receives which assets upon death, which can lessen the chance of fraud and theft.
Income in a Living Trust
The assets in a living trust often produce income, even while the grantor is still alive. Investment portfolios can generate interest, dividends and capital gains and real estate may produce rental income. Income on trust assets is paid directly into the trust, which will have its own bank accounts. The trust will receive any statements of account from brokers or other trustees in its own name, not the name of the grantor. The grantor retains ownership of all assets in the trust as well as all income generated by trust assets during his lifetime.
Although the trust is a legal entity, it is generally disregarded for tax purposes. The income generated in the trust flows through to the grantor while she is still alive. Even though the income is paid in the trust's name, it is reported on the grantor's personal tax return. The grantor provides the trustee with W-9 tax forms that indicate the social security number of the grantor. These forms are held by the payors and, at the end of each year, 1099 forms are issued to the grantor for income received on trust assets. The grantor includes the 1099 with her other tax forms and reports the income as if she had received it directly. The trust pays no income tax of its own.
A living trust often does not exist long after the death of the grantor. Assets in the trust are distributed to beneficiaries quickly and the trust is dissolved. However, if there is any income in the trust after the death of the grantor, it must be claimed as taxable income to the beneficiaries. The trust does not pay tax on these amounts. The trust must prepare and file form 1041 to notify the beneficiaries of their share of the trust's income that they must include in their taxes.