Trusts and estates are subject to taxation at their rates on any income that they generate
As individuals and businesses, estates and trusts are subject to taxation on their income. When an individual passes away, their estate takes "ownership" of the assets in their name. At the time of their passing, a person who has passed away might have held financial assets such as stocks, bonds, rental property, or other assets that produce interest and dividends. The trust or estate is responsible for reporting any income that results from the assets after the deceased person's passing.
The Return of Income to the Internal Revenue Service for Estates and Trusts
If an estate or trust has income during the year, it will be subject to the tax rates that the federal government has established. The tax brackets are changed annually to account for the effects of inflation, just like the tax brackets for personal income are. Form 1041, the United States Income Tax Return for Estates and Trusts, must be submitted as a mandatory requirement.
If all assets that produce income are left directly to a beneficiary after a person's death, then Form 1041 is not required. This could be the case with real estate owned jointly with the right of survivorship or with an individual retirement account (IRA) transferred directly to a spouse after the death of one of the owners.
When filing their tax returns, trusts and estates have the same ability as other taxpayers to claim certain deductions. They are eligible to make a deduction for any asset that is given to a beneficiary after they have done so.
The recipient's income distributions are reported on the recipient's copy of Schedule K-1, which is also sent to them. The Internal Revenue Service also gets a copy of it. After the distribution, the beneficiary is responsible for reporting the asset as income on their tax returns.
Who Is Required to File Form 1041 and Why?
Form 1041 of the Internal Revenue Service must be filed by any estate with a gross income of at least $600 for the tax year and any estate with a beneficiary who was a nonresident alien.
Trusts with any taxable income at all with a gross income of $600 or more, regardless of whether or not they have any taxable income, and trusts with any beneficiary who is a nonresident alien are all required to file Form 1041.
In order for an estate to file these documents and conduct other business, the estate must first apply for a tax identification number. Regardless of whether the estate has any workers under its employ, the identification number is an employer identification number (EIN). The Internal Revenue Service accepts EIN applications from estate executors submitted in person, via fax, or online.
Income Tax Brackets Applying to Estates and Trusts
When the Tax Cuts and Jobs Act (TCJA) became law and went into effect in January 2018, it altered the tax brackets in place for all types of income, including those assigned to income from estates and trusts.
Additionally, the TCJA changed the inflation index that is used to calculate the yearly increase in tax bracket figures. In the past, the Internal Revenue Code would periodically update the tax brackets based on the changes in the Consumer Price Index (CPI). In accordance with the provisions of the TCJA, it uses the chained CPI, which is somewhat more complicated. In most cases, this will result in a more modest adjustment for inflation.
The following table details the applicable tax rates and income brackets for trusts and estates established in 2021 in response to deaths that occurred that year. They would become effective for the tax return that is submitted in 2022.
Income Bracket
|
Tax Rate
|
| $0 to $2,650 |
10% of income over $0 |
| $2,650 to $9,550 |
$265 + 24% of income over $2,650 |
| $9,550 to $13,050 |
$1,921 + 35% of income over $9,550 |
| $13,050 or more |
$3,146 + 37% of income over $13,050 |
Estate taxes are not the same as income taxes in any way
These estate tax thresholds and exemptions are not to be confused with the tax brackets and rates that apply to individual income taxes. Only income earned by trusts or estates before assets are distributed to beneficiaries is subject to these taxes. Form IRS 706, the United States Estate (and Generation-Skipping Transfer) Tax Return, needs to be submitted to pay the estate tax, which is based on the estate's total value.
In the year 2021, the estate tax was only applicable to estates with a value of more than $11.7 million. This threshold also accounts for inflation when determining its value. For deaths that take place in 2022, the amount will rise to $12.06 million. When the Tax Cuts and Jobs Act was passed in 2018, it more or less doubled the amount of the estate tax exemption. If Congress does not take action to renew the provisions of the TCJA before it expires in 2025, these values could revert to what they were before 2018 (which was closer to $5 million).
Key Takeaways
- The income that estates and trusts bring in is subject to taxation, and these entities must file the IRS Form 1041, the United States Income Tax Return for Estates and Trusts.
- The tax rates and income brackets that apply to estates and trusts are different from those that apply to individuals and are adjusted annually to account for inflation.
- The thresholds and exemptions for the estate tax are not the same as the tax brackets and rates that apply to individual income taxes. Only income earned by trusts or estates before assets are distributed to beneficiaries is subject to the applicable tax rates and brackets.
Frequently Asked Questions (FAQs)
What sets a trust apart from an estate is that a third party manages it.
A trust is a specific type of relationship or arrangement in which a third party takes legal title to real estate or other assets for the benefit of another individual, known as a beneficiary. The laws of a state may permit the establishment of a trust. Probate is typically not required. When a person passes away, their possessions and other assets are referred to as their estate. An individual's home, possessions, assets, and even more can all be included in their estate.
What is the highest tax rate that applies to estates and trusts?
The amount that you must pay in taxes is $3,146, in addition to 37 percent of any income above $13,450. The rate of 37 percent applies to the trust, and the estate tax is the highest in the country. It applies to income higher than or equal to $13,450 for deaths occurring in 2022. One can find the instructions on how to file IRS Form 1041.
