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.
Gifts and inheritance Personal income types
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.
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.
Many people worry about the estate tax affecting the inheritance they pass along to their children, but it's not a reality most people will face. In 2025, the first $13,990,000 of an estate is exempt from federal estate taxes, up from $13,610,000 in 2024. Estate taxes are based on the size of the estate.
Once you put something in an irrevocable trust it legally belongs to the trust, not to you. Assets in an irrevocable trust do not contribute to the overall value of your estate which, for a particularly large estate, can shield those assets from potential estate taxes.
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.
Intentionally defective grantor trust (IDGT): An IDGT is another type of irrevocable trust. You transfer assets to the trust tax-free, but you must pay income tax on the revenue generated by the trust's assets. The assets in the trust can grow and be passed to your beneficiaries tax-free.
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.
The ability of a beneficiary to withdraw money from a trust depends on the trust's specific terms. Some trusts allow beneficiaries to receive regular distributions or access funds under certain conditions, such as reaching a specific age or achieving a milestone.
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.
Many states assess an inheritance tax. That means that you, as the beneficiary, will have to pay taxes when you receive an inheritance. How much you'll be assessed depends on the state you live in, the size of your inheritance, the types of assets included, and your relationship with the deceased.
Strategies to transfer wealth without a heavy tax burden include creating an irrevocable trust, engaging in annual gifting, forming a family limited partnership, or forming a generation-skipping transfer trust.
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. A trustee, who is named by the person who set up the trust, oversees the trust and manages it.
Gifts in trust are commonly used to pass wealth from one generation to another by establishing a trust fund. Typically, the IRS taxes the value of a gift being transferred up to the annual gift tax exclusion amount. A gift in trust is a way to avoid taxes on gifts that exceed the annual gift tax exclusion amount.
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.
Key Takeaways. Funds received from a trust are subject to different taxation rules than funds from ordinary investment accounts. 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.
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%.
Are distributions from a trust taxable to the recipient in California? Generally speaking, distributions from trusts are considered income and, therefore, may be subject to taxation depending on the type of trust and its purpose.
When a portion of a beneficiary's distribution from a trust or the entirety of it originates from the trust's interest income, they generally will be required to pay income taxes on it, unless the trust has already paid the income tax.
The trust fund loophole refers to the “stepped-up basis rule” in U.S. tax law. The rule is a tax exemption that lets you use a trust to transfer appreciated assets to the trust's beneficiaries without paying the capital gains tax. Your “basis” in an asset is the price you paid for the asset.
If the home is in a revocable trust when sold, tax liability is pretty straightforward. Property of a revocable trust is generally treated as owned by the grantor. That means that when selling a home in a revocable trust, the grantor selling the home is taxed on their capital gains on the sale.
Beneficiaries pay taxes on the income they receive from the trust. Capital gains are not considered income to such an irrevocable trust. Instead, any capital gains are treated as contributions to principal.
While the principal amount of the CD transfers without income tax issues, any interest earned after death and before transfer will be treated as ordinary income on the tax return of the person who inherits it.
For 2025, the federal estate tax threshold is $13.99 million for individuals, which means married couples don't have to pay estate if their estate is worth $27.98 million or less. For 2024, the threshold was $13.61 million for individuals and $27.22 million for married couples.