Trusts are popular financial and estate planning tools which offer a structured way to manage and distribute assets. When used wisely, these tools help planners meet these goals. However, a poorly drafted trust can result in unforeseen consequences, such as a large tax bill.
The savvy planner will take tax considerations into account when moving forward with an estate plan. The following will help provide a basic understanding of how state and federal tax obligations could impact the plan.
Step 1: Consider state tax obligations
It is important to research each state’s take on taxation of trusts. This step is relatively easy for those who live in Florida. In most cases, Florida state taxing authorities do not tax trusts.
Step 2: Consider federal tax obligations
The Internal Revenue Service (IRS) may expect the trust to pay taxes. When it comes to income taxes, the IRS generally breaks down grantor trusts in one of two categories:
- Revocable. This type of trust allows the grantor to retain control of the assets within the trust. As such, the assets are taxed as part of the grantor’s estate.
- Irrevocable. The IRS generally views this type of trust as a separate legal entity. As such, it may require its own tax return. The specifics depend on the trust’s provisions and the nature of the income.
The exact impact of taxes on trusts depends on the details of each individual situation.
Step 3: Careful planning can help you make the most of the benefits of a trust
In Florida, trusts can offer a strategic advantage for estate planning, potentially saving significant amounts in federal estate taxes through careful planning and utilization of exemptions. For beneficiaries, the impact on income taxes depends largely on the structure of the trust and how it distributes its income. Both grantors and beneficiaries are wise to understand these tax implications to effectively manage and plan their financial futures, better ensuring compliance with all relevant tax obligations while maximizing the benefits trusts can offer.