Trust beneficiaries must pay taxes on income and other distributions from a trust. Trust beneficiaries don't have to pay taxes on principal from the trust's assets. IRS forms K-1 and 1041 are required for filing tax returns that receive trust disbursements.
The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has: Any taxable income for the tax year, Gross income of $600 or more (regardless of taxable income), or. A beneficiary who is a nonresident alien.
Beneficiaries of a trust typically pay taxes on distributions they receive from the trust's income. However, they are not subject to taxes on distributions from the trust's principal.
Below are the 2024 tax brackets for trust income: $0 – $3,100: 10% $3,100 – $11,150: 24% $11,150 – $15,200: 35%
For all practical purposes, the trust is invisible to the Internal Revenue Servicc (IRS). As long as the assets are sold at fair market value, there will be no reportable gain, loss, or gift tax assessed on the sale. There will also be no income tax on any payments made to the grantor from a sale.
When you inherit money and assets through a trust, you receive distributions according to the terms of the trust, so you won't have total control over the inheritance as you would if you'd received the inheritance outright.
Assets in the trust are subject to federal estate and gift taxes (though no tax may be due if you have a sufficient amount of exemption remaining) only once - when they are transferred to the trust.
Another key difference: While there is no federal inheritance tax, there is a federal estate tax. The federal estate tax generally applies to assets over $13.61 million in 2024 and $13.99 million in 2025, and the federal estate tax rate ranges from 18% to 40%.
With the new IRS rule, assets in an irrevocable trust are not part of the owner's taxable estate at their death and are not eligible for the fair market valuation when transferred to an heir. The 2023-2 rule doesn't give an heir the higher cost basis or fair market value of the inherited asset.
The higher trust tax rates are due to the fact that an irrevocable trust has only hundreds of dollars in standard deduction, and an irrevocable trust pays the highest federal tax rate after just a few thousand dollars of income.
Q: Do trusts have a requirement to file federal income tax returns? A: Trusts must file a Form 1041, U.S. Income Tax Return for Estates and Trusts, for each taxable year where the trust has $600 in income or the trust has a non-resident alien as a beneficiary.
Income of a trust that has a tax identification number is reported to that tax identification number with a Form 1099, and a trust reports its income and deductions for federal income tax purposes annually on Form 1041.
Unearned includes investment-type income such as taxable interest, ordinary dividends, and capital gains distributions. It also includes unemployment compensation, taxable Social Security benefits, pensions, annuities, cancellation of debt, and distributions of unearned income from a trust.
Trusts are subject to a highly compressed tax bracket, reaching the highest federal income tax rate (37% as of 2024) once income exceeds $14,450. California's state income tax also applies to trust income, with rates as high as 13.3%.
Generally, beneficiaries do not pay income tax on money or property that they inherit, but there are exceptions for retirement accounts, life insurance proceeds, and savings bond interest. Money inherited from a 401(k), 403(b), or IRA is taxable if that money was tax deductible when it was contributed.
Inheritance checks are generally not reported to the IRS unless they involve cash or cash equivalents exceeding $10,000. Banks and financial institutions are required to report such transactions using Form 8300. Most inheritances are paid by regular check, wire transfer, or other means that don't qualify for reporting.
An irrevocable trust transfers asset ownership from the original owner to the trust, with assets eventually distributed to the beneficiaries. Because those assets don't legally belong to the person who set up the trust, they aren't subject to estate or inheritance taxes when that person passes away.
Beneficiaries of a trust are usually only taxed on the earnings portions of their distributions, and whether those earnings are taxed as income or capital gains depends on how they were earned. Who pays those taxes depends on how the trust was set up. Estate planning can be complicated, so it pays to be prepared.
Bottom Line. California doesn't enforce a gift tax, but you may owe a federal one. However, you can give up to $19,000 in cash or property during the 2025 tax year and up to $18,000 in the 2024 tax year without triggering a gift tax return.
Rich people frequently place their homes and other financial assets in trusts to reduce taxes and give their wealth to their beneficiaries. They may also do this to protect their property from divorce proceedings and frivolous lawsuits.
Selecting the wrong trustee is easily the biggest blunder parents can make when setting up a trust fund. As estate planning attorneys, we've seen first-hand how this critical error undermines so many parents' good intentions.
The grantor can set up the trust so the money is distributed directly to the beneficiaries free and clear of limitations. The trustee can transfer real estate to the beneficiary by having a new deed written up or selling the property and giving them the money, writing them a check or giving them cash.
If you received a gift or inheritance, do not include it in your income. However, if the gift or inheritance later produces income, you will need to pay tax on that income. Example: You inherit and deposit cash that earns interest income. Include only the interest earned in your gross income, not the inherited cash.
What Are the Disadvantages of a Trust in California? Trusts are costly to create. Creating a trust without an attorney may be less expensive, but doing so leaves the trust much more vulnerable to trust contests and other legal litigation. It is also more time-consuming to properly set up a trust than to create a will.