Taxation of Trusts — New York Estate Planning & Elder Law Blog — July 13, 2023
Revocable living trusts, where the grantor (creator) and the trustee (manager) are the same person, use the grantor’s social security number and are not required to file an income tax return. All income and capital gains taxes are reported on the individual’s Form 1040.
Irrevocable living trusts come in two main varieties, “grantor” and “non-grantor” trusts. Non-grantor trusts are often used by the wealthy to give assets away during their lifetime and for all income and capital gains taxes to be paid either by the trust or the trust beneficiary but not by them. Gifts to non-grantor trusts are reported to the IRS but are rarely taxable. Currently, the annual exclusion is $17,000 per person per year to as many people as you wish. However, if you go over the $17,000 to any one person you must report the gift to Uncle Sam, but they merely subtract the excess gift from the $12,920,000 each person is allowed to give at death. Most of our clients are “comfortably under” as we like to say. These gifts then grow estate tax-free to the recipient.
Grantor trusts, such as the Medicaid Asset Protection Trust (MAPT), are designed to get the assets out of your name for Medicaid purposes but keep them in your name for tax purposes. You continue to receive income from the MAPT and pay income tax the same as before. The MAPT files an “informational return” (Form 1041) telling the IRS that all the income is passing through to you. Gifts to non-grantor trusts take the grantor’s “basis” for calculating capital gains taxes on sale, i.e. what the grantor originally paid and, if real estate, plus any capital improvements.
In the grantor trust, however, no gift is made on the transfer to the trust because the grantor reserves the right to change who they leave it to on death. The gift is therefore said to be “incomplete” until death and is therefore includible in the grantor’s estate. Assets in the grantor’s estate receive a “stepped-up basis”. Instead of the grantor’s original basis, the heirs get the date of death value as the basis, resulting in capital gains taxes being due only on gains arising from the date of death to the date of sale, if any.
