Who Pays Taxes on the Trust?
When creating a trust, the original trust makers often ask, “will beneficiaries have to pay for income?” This article will address that.
When a trust makes an income distribution, it deducts the income distributed on its own tax return and will issue the beneficiary/ beneficiaries a tax form called a K-1. The K-1 shows the amount of interest income and principal is being distributed to the beneficiaries. As a result, the K-1 informs the beneficiaries what they must claim as taxable income, when filing taxes.
When trust beneficiaries get distributions from the trust’s principal balance, they do not have to pay taxes on the distribution. This is because the IRS assumes these specific funds were already taxed before it was placed into the trust. However, once the funds are placed into the trust, the interest it accumulates is taxable as income—either to the beneficiary or the trust itself. The trust is required to pay taxes on any interest income it holds and doesn’t distribute past year-end. On the other hand, interest income earned and the trust distributes is taxable to the beneficiary.
The amount distributed to the beneficiary is allocated as from the current-year income earned by the first, then from the accumulated principal after. The K-1 schedule for taxing distributed amounts is generated by the trust and given to the IRS, which will then send the document to the beneficiary for the filing of their own respective taxes.
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