Whenever someone writes you a check, there's a question as to who is going pay taxes on the money. If you earned the money, the answer is relatively simple – you do. If the money is an inheritance, however, and particularly if it's an inheritance from a trust, the issue becomes more complicated. The answer depends on the type of trust and what portion of its assets it paid out to you.
Taxability of Revocable Trusts
While the creator or grantor of a revocable trust is alive, he can typically elect to take distributions from his trust if he chooses to. That's the nature of a revocable trust – the grantor reserves the right to change his mind about it and about the assets it holds. Therefore, tax law typically treats the grantor and his trust as one legal entity during his lifetime. Any income that trust inheritance assets earn is reported on the grantor's personal return and he pays taxes on it. When the grantor dies, however, this has the effect of changing his revocable trust to an irrevocable trust because he can no longer make changes to it. What happens next for tax purposes depends on how he designed the trust at its inception.
If you inherit from a simple trust, you must report and pay taxes on the money. By definition, anything you receive from a simple trust is income earned by it during that tax year. The trustee must issue you a Schedule K-1 for the income distributed to you, which you must submit with your tax return. If you inherit money from a complex trust, however, the funds might represent either income or capital gains. The portion representative of the trust's income is ordinary income and is reportable by you on your tax return. You'll receive a Schedule K-1 for the amount. Any portion of the money that derives from the trust's capital gains is capital income, and this is taxable to the trust. This is typically the case when the trust's distributions for the year exceed the amount of income it took in.
A trust takes deductions on its own income tax return for distributions of ordinary income made to beneficiaries – the Internal Revenue Service does not tax this money twice. Tax liability passes through the trust and lands with you as the trust beneficiary. In the case of a complex trust, however, the trust would still owe taxes on any ordinary income it retains. This is usually not to a trust's advantage.
Exceptions for Irrevocable Trusts
When a revocable trust becomes irrevocable at the grantor's death, one of two things happens according to the terms included in the trust's creating documents. Its assets are either distributed to beneficiaries immediately and the trust closes, or it becomes a new trust – either simple or complex. Simple trusts must distribute all income earned by their assets in the same year the income is received. Complex trusts can hold on to some income, distributing only a portion of it to beneficiaries. More important, simple trusts cannot disburse from the principal of their assets – those that initially funded the trust, plus capital gains. Complex trusts can distribute from capital gains, and this is where an important IRS inheritance tax distinction applies.
2018 Tax Law
If the trust includes business income, there's good news for heirs. Under IRC Section 199A, business income is subject to a 20 percent deduction, divided between the estate and its beneficiaries. The tax brackets have also changed under the TCJA act, so if you're subject to ordinary income, you'll find that you're taxed differently in 2018 as opposed to 2017.
2017 Tax Law
If you're filing taxes for the 2017 tax year, you won't be able to take the new 20 percent deduction for business income. You'll need to follow the 2017 tax brackets for trusts and estates, with a tax rate of 20 percent if taxable income exceeds $12,500.
FAQs
When trust beneficiaries receive distributions from the trust's principal balance, they don't have to pay taxes on this disbursem*nt. The Internal Revenue Service (IRS) assumes this money was taxed before being placed into the trust. Gains on the trust are taxable as income to the beneficiary or the trust.
Is money inherited from a revocable trust taxable? ›
The portion of the trust property passing to the individual beneficiaries will be subject to estate taxes and the portion passing to the charities will be distributed free from estate taxes.
Are inheritance distributions from a trust taxable? ›
This means that if you receive a distribution from the trust's principal, it is usually not considered taxable income for you. The trust itself, however, may owe taxes on any income it generates, such as interest, dividends, or rental income.
What happens when you inherit money from a trust? ›
In either case, inheriting money held in trust means you will not receive an outright distribution of your inheritance to manage and spend yourself. Instead, you will have some right to use trust funds for specific purposes. In this situation, the criteria for distributions will be laid out in the trust document.
Do I need to report inheritance to IRS? ›
In general, any inheritance you receive does not need to be reported to the IRS. You typically don't need to report inheritance money to the IRS because inheritances aren't considered taxable income by the federal government. That said, earnings made off of the inheritance may need to be reported.
Do I have to pay taxes on money received from a trust? ›
Distributions From Trust Income
When a portion of a beneficiary's distribution from a trust or the entirety of it originates from the trust's interest income, they generally will be required to pay income taxes on it, unless the trust has already paid the income tax.
How much can you inherit without paying federal taxes? ›
There is a federal estate tax, however, which is paid by the estate of the deceased. In 2024, the first $13,610,000 of an estate is exempt from the estate tax. A beneficiary may also have to pay capital gains taxes if they sell assets they've inherited, including stocks, real estate or valuables.
How does a beneficiary get money from a trust? ›
The grantor can opt to have the beneficiaries receive trust property directly without any restrictions. The trustee can write the beneficiary a check, give them cash, and transfer real estate by drawing up a new deed or selling the house and giving them the proceeds.
What is the trust tax loophole? ›
The trust fund loophole lets you transfer assets to your heirs without paying the capital gains tax. High-income earners pay the highest capital gains tax rate. So, the loophole benefits them most. Politicians frequently try to close the loophole.
Why did I get a 1099 for inheritance? ›
This means that when the beneficiary withdraws those monies from the accounts, the beneficiary will receive a 1099 from the company administering the plan and must report that income on their income tax return (and must pay income taxes on the sum).
The short answer is yes: A trustee can access trust accounts that were created and funded by the settlor.
Do you pay capital gains on inherited property in a trust? ›
It's worth noting that the threshold rates for the different capital gains tax brackets are different for estates and trusts than they are for individuals. The capital gains tax is still paid, but it's out of the proceeds of the trust so that beneficiaries don't have to deal with it.
Is it better to put inheritance in a trust? ›
Depending on your situation, your beneficiaries may benefit from having your assets in a trust. Not having to go through probate is beneficial if they need access to funds to pay bills and maintain property in your estate. Trusts generally avoid state probate requirements and the associated expenses.
Does the IRS know when you inherit money? ›
Inheritance checks are generally not reported to the IRS unless they involve cash or cash equivalents exceeding $10,000. Banks and financial institutions are required to report such transactions using Form 8300. Most inheritances are paid by regular check, wire transfer, or other means that don't qualify for reporting.
Can my parents give me $100 000? ›
Can my parents give me $100,000? Your parents can each give you up to $17,000 each in 2023 and it isn't taxed. However, any amount that exceeds that will need to be reported to the IRS by your parents and will count against their lifetime limit of $12.9 million.
Which states impose an inheritance tax? ›
States that currently impose an inheritance tax include:
- Iowa (but Iowa is in the process of phasing out its inheritance tax, which was repealed in 2021; for deaths in 2021-2024, some inheritors will still have to pay a reduced inheritance tax)
- Kentucky.
- Maryland.
- Nebraska.
- New Jersey.
- Pennsylvania.
Although a revocable trust may provide some tax and estate planning benefits, it does not avoid capital gains tax. Further, a revocable trust does not help one for Medicaid planning.
