Murfreesboro divorce attorney

How Is a Trust Taxed?

Trusts are a versatile estate planning tool and are commonly found in the average estate plan. A trust can provide significant benefits, including asset protection, estate tax reduction, and efficient wealth transfer. Understanding the tax implications of a trust, however, is crucial for maximizing its benefits and avoiding potential pitfalls. To help get you started, a Murfreesboro estate planning attorney at Bennett | Michael | Hornsby explains how a trust is taxed.

Trust Basics

The tax treatment of a trust largely depends on its type. A trust is created by a Grantor, also referred to as a Settlor or Trustor. A trust is aMurfreesboro divorce attorney fiduciary arrangement where a Trustee, appointed by the Grantor, holds and manages assets for the benefit of beneficiaries according to the terms set by the Grantor and found in the trust agreement, the legal document used to establish a trust. All trusts are categorized as testamentary or living trusts, with the former not activating until the death of the Grantor and the latter activating during the lifetime of the Grantor. A trust can also be revocable or irrevocable. A revocable trust can be revoked or modified by the Grantor at any time and for any reason while an irrevocable trust cannot be revoked or modified after the trust is established. Within these general categories, there are also numerous specialized trusts established for a specific purpose, such as a charitable trust, Medicaid trust, or an Irrevocable Life Insurance Trust (ILIT).

Trusts and Income Taxes

Because the Grantor retains control of the assets held in a revocable trust, the IRS treats the trust’s income as the Grantor’s income. Therefore, all income generated by the trust’s assets is reported on the Grantor’s personal tax return, and the Grantor pays taxes at their individual tax rate.

An irrevocable trust, however, cannot be easily altered or terminated by the Grantor. Moreover, the trust itself is considered a separate legal entity, meaning the trust must file its own tax return using IRS Form 1041. The taxation of an irrevocable trust depends on whether the income is retained in the trust or distributed to the beneficiaries.

When an irrevocable trust retains income, that income is subject to trust tax rates, which are typically more compressed than individual tax rates. This means that higher tax rates apply at much lower levels of income. For example, in 2024, a trust reaches the highest federal tax bracket of 37% at just over $15,200 of taxable income, compared to over $609,350 for individuals.

If the trust distributes income to beneficiaries instead of retaining the income, the beneficiaries report this income on their personal tax returns and pay taxes at their individual rates. The trust receives a deduction for the distributed amount, reducing its taxable income. The trust must provide beneficiaries with a Schedule K-1 form, detailing their share of the distributed income.

Trusts and Capital Gains Tax


Capital gains realized within a trust are typically taxed at the trust level, unless distributed to beneficiaries. Trusts benefit from the same preferential tax rates on long-term capital gains and qualified dividends as individuals, but they reach the higher rates more quickly.

Special Trusts and Taxes

While all trusts require the same basic components for creation, a trust can be highly specialized to meet specific needs and objectives. Some of these specialized trusts are designed with tax avoidance in mind. As such, these specialized trusts come with specialized tax rules. A few common examples include:

  • Intentionally Defective Grantor Trust (IDGT): Certain irrevocable trusts are structured as Grantor trusts for income tax purposes, meaning the Grantor is treated as the owner of the trust income. This includes intentionally defective grantor trusts (IDGTs) commonly used in estate planning. The Grantor pays income taxes on trust earnings, but the trust’s assets are removed from the grantor’s estate for estate tax purposes.
  • Charitable Remainder Trusts (CRTs): A CRT is a tax-exempt irrevocable trust that generates income for the Grantor or other beneficiaries for a specified period, after which the remaining assets go to a charity. The Grantor receives an immediate charitable income tax deduction for the present value of the remainder interest passing to charity. Income generated by the CRT is taxed to the non-charitable beneficiaries when distributed.
  • Qualified Personal Residence Trusts (QPRTs): A QPRT allows the Grantor to transfer a personal residence to a trust while retaining the right to live in the home for a specified period. The value of the gift is discounted for tax purposes, and any appreciation in the home’s value is removed from the Grantor’s estate. If the Grantor outlives the trust term, the residence passes to the beneficiaries with significant estate tax savings.

Trusts and State Taxes

Whether or not a trust owes state taxes can vary significantly by state and can impact both the trust and its beneficiaries. Some states tax trusts based on the residency of the Grantor, Trustee, or beneficiaries, while others consider where the trust is administered. Check with an experienced trust attorney to ensure that you understand how a specific trust is taxed.

Contact a Murfreesboro Estate Planning Attorney 

If you have additional questions about trusts and taxes, consult with an experienced Murfreesboro estate planning attorney at Bennett | Michael | Hornsby as soon as possible. Contact the team today by calling 615-898-1560 to schedule your free appointment.


Stan Bennett