Who pays tax on irrevocable trust income?

Tax Liability of Irrevocable Trusts

Income Taxation of Trusts

- Simple Trusts: These trusts must distribute all income annually and do not retain the right to distribute the corpus or make charitable contributions.

- Complex Trusts: These are trusts that do not meet the definition of a simple trust or a grantor trust under the Internal Revenue Code.

- Grantor Trusts: If the grantor retains certain powers or benefits, the trust's income is taxed to the grantor, not the trust.

Irrevocable Trust Taxation

- An irrevocable trust, once established, generally cannot be modified or revoked.

- The tax responsibility depends on the type of trust:

 - If it is a grantor trust, the grantor is treated as the owner of the assets, and all income is taxed to the grantor.

 - If it is a simple or complex trust, the trust itself may be responsible for paying taxes on income it retains, while income distributed to beneficiaries may be taxed to the beneficiaries.

Filing Requirements

- Form 1041: This form is used by the fiduciary of a domestic decedent's estate, trust, or bankruptcy estate to report the income, deductions, gains, losses, etc., of the estate or trust.

 - Income that is either accumulated or held for future distribution or distributed currently to the beneficiaries is reported on this form.

 - Any income tax liability of the estate or trust is also reported here.

 - Schedule K-1 (Form 1041) is used to report a beneficiary's share of the estate’s or trust’s income, credits, deductions, etc.

Conclusion

The responsibility for paying taxes on the income generated by an irrevocable trust depends on the trust's classification under the tax code. If the trust is a grantor trust, the grantor is liable for the taxes. If the trust is a simple or complex trust, the trust itself may be liable for taxes on undistributed income, and the beneficiaries may be liable for taxes on the income that is distributed to them. The fiduciary of the trust must file Form 1041 to report the trust's income and distributions and provide Schedule K-1 to beneficiaries for their tax reporting purposes.

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Sources:

Abusive Trust Tax Evasion Schemes - Questions and Answers 2024-07-29

About Form 1041, U.S. Income Tax Return for Estates and Trusts 2024-08-03

Publication 1635 (Rev. 2-2014) - Internal Revenue Service 2024-08-03

Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2023) 2024-08-03

23 Future Developments - Internal Revenue Service 2024-08-02

Publication 559 (2023), Survivors, Executors, and Administrators 2024-08-03

Do you need an EIN? | Internal Revenue Service 2024-08-03

How to Apply for an EIN - Internal Revenue Service 2024-07-31

Instructions for Form 709 (2023) | Internal Revenue Service 2024-08-01

5.17.2 Federal Tax Liens | Internal Revenue Service 2024-08-01