Trust Beneficiary and Taxes

If you’re a trust beneficiary, you stand to receive significant income and assets when it’s time for distribution. But what happens when it comes to taxes? While it’s true that beneficiaries do have to pay taxes on the distributions they receive, the tax law regarding trusts is a little different than that governing wills or investment accounts. Because the tax situation for a trust beneficiary can be a bit complicated, it’s a good idea to know what to expect before it comes time to receive your distribution.

How Are Trusts Taxed?

If you’re a trust beneficiary, you  may receive distributions from either the trust’s principal balance or its income. While you’re required to pay taxes on money or assets you receive from the income, you are not obligated to do so for distributions from the principal. The reason that you do not have to pay taxes on the principal is because it is already assumed that the money was taxed prior to being placed into the trust. Any additional money that the trust makes has not been assessed yet and must be taxed upon distribution.

When you receive a distribution of any kind from a trust, the trust will issue you a special tax form known as a K-1. The K-1 breaks down the distribution and shows how much of the distribution is from the principal and how much from the income. The trust will also fill out a 1041 when it makes a distribution. This allows the trust to deduct the interest from its own taxable income.

Further Questions and Considerations

• How is the Nature of the Distribution Decided? For tax purposes, the distribution is usually considered to be drawn first from the income earned by the trust in the current year. After that, the distribution comes from the accumulated principal, which is the original contribution plus any later deposits.
• How Will Distributions Received from the Trust’s Income Be Taxed? Distributions are usually taxed as either ordinary income or capital gains, depending on the type of asset distributed.
• How Will the Distributions Be Received? Unlike with simple wills, assets from a trust are usually distributed to the beneficiaries in one of three ways. Outright distributions are given in lump payments and face no restrictions. Staggered distributions are made over a period of time or after a specific event. Discretionary distributions are given at specific times according to the grantor’s instructions and at the Trustee’s discretion.

Contact The Law Firm of Christopher W. Dumm

If you have questions about your tax obligations as a trust beneficiary, please do not hesitate to reach out to the Law Firm of Christopher W. Dumm. We are experienced in all areas of estate planning and trust management, and we’re here to address any concerns you might have. Give us a call at 417-623-2062 or fill out the contact form below to get started.