We are going to address the subject of taxation on living trust distributions in this post, but first, we should explain some of the benefits that these trusts provide.
Versatility and Efficient Estate Administration
When you are getting your affairs in order, you obviously have to express your wishes with regard to the way you want your assets to be transferred. At the same time, you should consider the administration process that will take place after your passing.
If you use a simple will as your asset transfer vehicle, there is not a lot of flexibility. Unless you add a testamentary trust, the assets will be distributed to the beneficiaries in lump sums.
This may be fine for some people on your inheritance list, but you could have a poor money manager in the family. Short of this, you may prefer to arrange for your loved ones to receive ongoing distributions over an extended period of time for your own reasons.
The inheritors must play a waiting game when a will is used, because it would be admitted to probate. This is a time-consuming process that takes place under the supervision of a court.
It will typically take about eight to 18 months for an estate to be probated depending on the complexity. No inheritances are distributed until the court has probated and closed the estate.
In addition to the time consumption, anyone who wants to pry into your final affairs can access probate records. Additionally, there are a number of expenses that reduce the value of the estate.
When a living trust is used, the trustee who you name in the document would be able to distribute assets outside of probate. You would control the way the assets are transferred to the beneficiaries, so you could allow for incremental distributions if you choose to do so.
Disability Protections and Planning for Married Couples
Many people shy away from trusts because they think that you no longer have access to the resources, but this is simply not the case with a living trust. If you establish a living trust, you would be the trustee while you are alive, so you would have total control of the assets in every way.
Unfortunately, a significant percentage of elders become unable to make sound decisions at some point in time. Alzheimer’s is a leading culprit, but there are other causes of incapacity. To account for this, you can name a disability trustee to manage the trust if it ever becomes necessary.
A living trust can be a great estate planning tool for married couples who have a good bit of jointly owned property that they want to leave to one another. Each person would still have the ability to direct their own separate property to beneficiaries of their choosing.
Taxes on Living Trust Distributions
Now that we have provided a bit of an overview, we can get to the point of this post.
Assets that you convey into a living trust were still in your possession after you paid taxes on your income. There are no taxes on distributions of the principal, because it would be an exercise in double taxation.
However, distributions of interest that is earned by assets in the trust would be looked upon as taxable income by the IRS and state tax authorities. Beneficiaries would pay taxes on distributed appreciation, and the trust itself would have to pay taxes on undistributed interest earnings.
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