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How Are Revocable and Irrevocable Trusts Taxed?

For the most part, trusts don’t pay taxes on their income, instead passing the income through to the trust beneficiaries. But when they do pay taxes, the tax rates are often higher than those for individual taxpayers. Here’s how this works.

Revocable Trusts

If you are the trustee of your own revocable trust, you use your own Social Security number for your accounts and report the trust income just like your own. If you are not the trustee, some tax specialists advise that the trust should have its own tax identification number (sometimes referred to as an 04 number), but few trustees take this step, since even if they did, the trust grantor would pay taxes on any income.

Irrevocable Trusts

All irrevocable trusts must obtain their own tax ID number and file their own 1041 tax return to report any income earned. Irrevocable trusts are divided into two types for tax purposes—grantor trusts and non-grantor trusts. Grantor trusts are those in which the creator of the trust—the grantor—retains significant benefits or rights, such as the right to receive all the trust income or change trustees. Grantor trusts file their own informational returns, reporting the trust income, but do not pay any income tax. Instead, they issue a k-1 form to the grantor, akin to a 1099, telling the grantor how much to report on her tax return. (There are arguments that some grantor trusts do not need their own tax ID number or have to file a return, but the standard practice is to do so with all irrevocable trusts.)

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