Taxability of Trusts: How Are Trusts Taxed?
Are trusts tax-exempt? Many people assume they are, or that, at the very least, all trusts enjoy tax benefits and protection from creditors, but these assumptions would be false. Trusts often are subject to the same types of taxes as individuals.
Understanding Tax Brackets for Trusts
There are several types of taxes that could apply to trusts; however, since how a trust is taxed will depend on factors like the type of trust it is and the way the trust is structured, it is a good idea to enlist the help of a probate attorney or tax professional if you are the successor trustee to ensure that you not only follow the provisions of the trust, but the relevant trust tax rates as well.
In the following sections, we discuss the most common taxes that apply to a trust after the settlor dies, as well as list the most current trust tax rates and brackets.
Trust Income Tax Rates
Given that many trusts earn income, taxes will need to be paid on that income, just as most individuals and businesses have to pay taxes on the income they earn. Below, we briefly discuss the tax rates generally applicable to ordinary income tax and capital gains tax. H5: Ordinary Income Tax Rates
When a settlor dies, the responsibilities of the person or entity whom they appointed to be the successor trustee will begin. One of those responsibilities may be generating income for the trust or managing the income it already generates. Whether or not the trustee is obligated to perform this function ultimately will depend on the terms of the trust, the types of assets the trust holds and the duration for which the trustee will hold the assets.
Like individuals, a trust can own assets, such as stocks and bonds, which may earn dividends, or real estate, which may earn rental income. In the same way individuals must pay taxes on such income, trusts must do so as well.
While a settlor is living, income earned by property in a revocable living trust can be declared on the settlor’s individual tax return; however, once a trust becomes irrevocable, a separate tax ID number will need to be obtained and a separate tax return filed for all the income earned by trust assets.
What is the federal income tax rates for trusts? Are trusts taxed at a higher rate? As the chart below demonstrates, trust tax rates are higher than individual tax rates.
Federal trust income tax rates for 2024 are:
- For trust income between $0 to $3,100: 10% of income over $0
- For trust income between $3,100 to $11,150: 24% of the amount over $3,100
- For trust income between $11,150 to $15,200: 35% of the income over $11,150
- For trust income above $15,200: 37% of the amount over $15,200
Federal trust income tax rates for 2023 were:
- For trust income between $0 to $2,900: 10% of income over $0
- For trust income between $2,901 to $10,550: $290 + 24% of the amount over $2,901
- For trust income between $10,551 to $14,450: $2,126 + 35% of the amount over $10,551
- For trust income above $14,451: $3,491 + 37% of the amount over $14,451
- For trust income between $0 to $10,099: 1% of income over $0
- For trust income between $10,100 to $23,942: 2% of income over $10,100
- For trust income between $23,943 to $37,788: 4% of income over $23,943
- For trust income between $37,789 to $52,455: 6% of income over $37,789
- For trust income between $52.456 to $66,295: 8% of income over $52,456
- For trust income between $66,296 to $338,639: 9.3% of income over $66,296
- For trust income between $338,640 to $406,364: 10.3% of income over $338,640
- For trust income between $406,365 to $677,275: 11.3% of income over $406,365
- For trust income above $677,276: 12.3% of income over $677,276
It’s important to keep in mind that your county may also charge an income tax and that trust tax rates can vary considerably from year to year, so it is important for trustees to either keep themselves apprised of the latest tax rules or work with an attorney or tax professional who knows and understands them.
Trust Capital Gains Tax Rates
Trust taxation of capital gains can be complex to navigate. Taxes are levied on trusts only when their investments, such as stocks and real estate, are sold for a higher value than their base price. If a trust holds an investment for longer than a year before selling, it will be subject to the lower capital gains tax on account of it being a long-term gain. If a trust holds an investment for less than a year, the trust would pay short-term capital gains taxes at a higher rate.
The federal capital gains trust tax rates on long-term gains for 2024 are:
- Up to $3,150: 0%
- Between $3,150 – $15,450: 15%
- Over $15,450: 20%
If you live in California, you may be wondering what the long-term capital gains tax rates are in the state. As of 2024, California taxes long-term capital gains in the same way it taxes ordinary income, meaning capital gains are taxed between 1% and 13.3%, depending on your income level. There isn’t a lower capital gains tax for long-term gains in California.
The federal capital gains trust tax rates on long-term gains for 2023 were:
- Up to $44,625: 0%
- Between $44,626 – $492,300: 15%
- Over $492,300: 20%
Capital gains taxes often can be offset by capital losses. For example, if a trust sells one real property for a substantial profit but sells another real property for below fair market value, the capital loss the trust suffered may nullify a portion of or all of its capital gain, placing the trust in a lower capital gains trust tax bracket, or none at all.
If you are a trustee, it’s important to have a general understanding of the difference between unrealized gains and realized gains. An unrealized gain exists in theory. For instance, a trust may own stocks that have increased significantly in value since the time of their purchase, but until those stocks are sold, they are considered unrealized gains and therefore are not subject to capital gains tax. On the other hand, if a trust owns real property that it sells for a profit, it is considered a realized gain and is subject to capital gains tax
Trust Gift Tax Rates
If an asset is transferred during the life of one party to another without the gifter receiving fair market value in return, it’s possible the person making the gift may be subject to a gift tax, particularly if the value of the asset exceeds the gift tax exclusion amount, which is $18,000 as of 2024. If more than $18,000 is gifted to the recipient in a year, it will count against both the lifetime gift exclusion and federal estate tax exclusion of $13.61 million.
It’s worth mentioning that some types of trusts, depending on their provisions and how they are structured, may be exempt from gift taxes. For example, irrevocable charitable trusts that are established for the benefit of a charitable foundation may be exempt. Similarly, trusts that are designed to provide the surviving spouse with income during their lifetime, such as qualified terminable interest property trusts (QTIPs) and spousal lifetime access trusts (SLATs), may also be exempt.
It’s best to consult with an attorney or tax professional before claiming exemptions to ensure the trust you oversee qualifies for them.
Trust Estate Tax Rates
Estate taxes (also referred to as “death taxes”) are levied when assets are transferred from a deceased person to beneficiaries. If a decedent’s assets are held in a probate estate, then the executor or administrator of the estate will be responsible for paying the estate tax. Conversely, if a trust has assets that are subject to the estate tax, then the trustee will be responsible for paying this tax prior to transferring the assets to beneficiaries.
That being said, most trusts will not be responsible for paying an estate tax, as estate taxes only are levied on a decedent’s assets valued at $13.61 million or higher (or double that amount for married couples) as of 2024.
Even if a decedent’s assets have a gross value that exceeds the applicable estate tax exemption amount, the estate still may not be subject to estate tax if certain exceptions apply. For example, if the decedent’s will or trust provides substantial gifts to charitable entities, the gifts may qualify for a charitable deduction that reduces the taxable estate. Decedents who leave property to their surviving spouse may also benefit from a marital deduction that exempts property passing to a surviving spouse from estate taxes.
Trust Property Tax Rates
If a trust owns real estate (which many do), then it’s almost certain that the trustee will have to pay county and state property taxes on each of the properties it owns. The trustee must use the assets of the trust to satisfy this obligation.
Once the trustee transfers a real property to beneficiaries, it will become their responsibility to pay property taxes on it annually from that point onward until they sell or transfer it to another party.
Because property taxes are generally levied on a state and local level, it is difficult to provide specifics. However, we can say that as of 2024, the median property tax in California is $4,831.
Certain types of trusts, such as charitable trusts, religious trusts or educational trusts, may be exempt from having to pay property taxes. To determine if the trust you manage qualifies for a property tax exemption, speak with an experienced attorney or tax professional.
