A revocable living trust in North Carolina is a legal arrangement that someone establishes during their lifetime for their own benefit and for the benefit of designated people after their death. When a living trust is revocable, it can be amended or revoked during the lifetime of the trustmaker, or grantor. To be given full legal effect upon the death of the grantor, the trust document must be signed before two witnesses and a notary.
Revocable living trusts are used to avoid probate (court supervised estate administration) at death, and to reduce the time delay and costs involved in transferring assets to the trust beneficiaries. But if you set up a revocable living trust in Greensboro, North Carolina, does that require a change to your income taxes? Will you need to file a separate income tax return for your revocable living trust? And who pays the tax on income earned by the trust assets?
Here is a brief summary of how the income taxes work for a revocable living trust.
Creating a revocable living trust while you are living
When you create a revocable living trust, you will sign a document as the “grantor” (that’s the individual who forms the trust and creates the trust agreement). Under the terms of the trust, you can amend or even revoke the trust. In addition, when you’ve transferred your personal assets into the trust, you’ll still be entitled to receive the trust income and principal. As a result, the IRS rules require that you’re still taxed on all of the income earned by the trust assets. That means that your own Social Security number will be used for the trust’s bank accounts and investments. It also means that as long as you live, all of that income is reported to your own tax return, so you won’t need to file a separate trust tax return.
Isn’t that relief? Your revocable living trust will not complicate or change your taxes. However, even though the IRS considers these trust assets to be taxed to you personally, those assets that are in the trust will avoid probate estate administration at your death.
After your death
When the grantor passes away, the trust will continue. The trust becomes its own separate taxable entity and as a result it will need its own taxpayer identification number. The final tax return will be filed by the grantor’s executor or trustee, for income earned through your death. The income earned by trust assets after your passing will be listed on the trust’s own, separate income tax return. The trust will need to file an annual fiduciary income tax return (on Form 1041). When the now irrevocable trust makes distributions to beneficiaries, then generally the trust will deduct from income the distributions made. The beneficiaries will recognize a portion of the distribution received as income on their own income tax return. It is important to note that not all of the distribution is taxable to the beneficiary: the distribution is taxable only to the extent that it represents income that the trust assets earned. The rest of the distribution is a nontaxable return of premium.
The beneficiaries will need to wait each year until they receive a report for the trust about the income to be reported on the beneficiary’s own individual income tax return. If the beneficiary files his or her tax return too early and fails to include his or her share of trust income, the beneficiary will need to file an amended trust tax return (Form 1040X).
If the trust does not make distributions to beneficiaries, then the trust will pay taxes on its own income. In that case, the beneficiaries will not need to recognize income since they did not receive a distribution.
Legal Benefits of A North Carolina Living Trust
By setting up a living trust in North Carolina, you are able to help the designated recipients of the trust avoid costly expenses and a lengthy court process.
Also, in the case of incapacity of the grantor, a living trust in North Carolina will help avoid court administered guardianship. Typically in a living trust agreement, in the event of a grantor’s incapacity a successor beneficiary takes over the administration of the trust. Families are able to avoid a public guardianship if they are unable to manage the trust.
Another benefit is the avoidance of probate upon the grantor’s death. Probates in these cases are avoided because a revocable living trust property is not titled in the name of the grantor at the time of death, but instead the successor, and therefore the property is not part of a probate estate.
Setting up a Revocable Living Trust in Greensboro, NC
If you are interested in setting up a revocable living trust in Greensboro, North Carolina, speak to an experienced attorney. Living trusts are complicated legal documents that have significant consequences. Speak with one of our experienced attorneys today to see if a revocable living trust fits with your family’s overall estate and asset protection plan.