18 Apr Trust Distribution Tax

Every April the Internal Revenue Service comes knocking on the door, looking for 1040s, 1099s, Schedule Cs, and a check for the bottom line. At Phelps LaClair, serving Mesa, Chandler, Gilbert, and the Phoenix Valley, we are sometimes asked by our clients if they will need to pay a trust distribution tax. What many want to know is, will they be taxed on income from an inheritance?

A Real Life Story

A couple received a modest inheritance of $85,000 from the wife’s elderly mother. The following April they received a Form 1099-B from the investment firm that had paid out the mother’s inheritance to them. Their initial thought was that they would owe 15% of the entire distribution ($12,750) to the Federal government for this income. But in actuality, the amount due the IRS was only $340. Why was the tax due such a small percentage?

Principal or Interest?

When money is placed into a trust, the IRS assumes that income taxes have already been paid on this amount. When there is a distribution from this principal amount, it is not taxed again. However, if the trust has accumulated interest through investment of principal, for example, that interest is considered to be income and is taxed. If the trust does not distribute any of the principal, then the trust is liable to pay the taxes on the interest earned each year. If the trust distributes from the principal to a beneficiary, then the beneficiary will be taxed on the interest earned.

Trust Distribution Tax

So in the case of the couple in the story above, the principal and interest from the mother’s trust was distributed upon her passing. The couple only had to pay income taxes on the interest accrued from the time of their mother’s passing to the time of the distribution. It was a savings to them of thousands of dollars.

Advantages of Having a Trust

Estate planning is a specialty field. There are many options available to help you protect your assets and control who receives the estate you leave behind. As a second generation estate planning firm, Phelps LaClair has the experience to design a custom plan for every estate. We will help you find the best vehicle for your situation, that will cover everything from long-term care planning to trust distribution tax. Call us today for an appointment. It’s never too early to plan wisely.

Images used under creative commons license (Commerical Use) 04/18/19    Photo by Sarah Pflug from Burst