Many families have used trusts for decades to pass wealth to spouses, children and grandchildren with reduced or no estate or gift tax burden. However, today the top income tax bracket is 39.6% plus the new 3.8% surtax on investment income for high earners (total top federal income tax rate 43.4%). One such earner is a trust. Trusts with investments that pay interest or dividends earn income for federal tax purposes. Trusts also have compressed income tax rates. So when a trust reaches $12,150 (2014) of income it hits the top tax rates. An individual can earn up to $406,750 before hitting the top rate.
If a trust beneficiary is in a lower income tax bracket than the trust, it may be beneficial to pay out some of the accumulated trust income. The beneficiary would pay a little more in tax and the trust would pay less in tax. So long as the net tax paid is less than if the income is retained in the trust, it may make sense to pay the beneficiary some additional income.
It is important to do the math before making the decision. Plus there are other things to consider such as the trust’s investment goals and policies and the needs of all beneficiaries, both current and in the next generation.
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