by Laura Johnson, EA
It sounds so…simple. But what is a simple trust, really? If you are the beneficiary of a simple trust, you pay tax on its income each year, whether or not you receive it. Usually, though, you will receive the income, if not during the year, then after it ends. “Income” can mean something other than what you are used to when trusts are concerned. For example, income of a simple trust usually (but not always) excludes capital gains.
Here is more about simple trusts.
By definition, a simple trust is a trust:
- That requires all income must be distributed currently.
- That doesn’t provide any amounts to be paid, permanently set aside, or used for charitable purposes.
- That doesn’t distribute amounts allocated to the corpus of the trust.
What is income?
Income is dictated by the terms of the trust, and where the trust document is silent, is determined by state law in the state where the trust was created. Both can vary, sometimes significantly, from one trust and one state to the next. Trustees might also have discretion about what to treat as income. In limited circumstances for example, a trustee can elect to include capital gains, typically a component of corpus, in income.
What does it mean to distribute income currently?
“Distributed currently” is a bit of a misnomer. The beneficiary is required to include the income from a simple trust in her gross income for the tax year regardless if she received it. It can complicate the tax treatment of the trust if income isn’t distributed, so we recommend actual distribution in most cases.
What does it mean not to distribute amounts allocated to corpus?
The “corpus” of a trust is the trust property. Usually, income associated with the trust property is added to the trust, net of any related expenses. So long as a trustee does not invade and distribute trust property by making distributions in excess of trust income, the trust will retain simple trust status.
If a trust is not a simple trust, then what is it?
If the trust is not a simple trust then it is a complex trust or a grantor trust. A grantor trust is more or less ignored for tax purposes: the grantor pays tax on all the income and takes all related deductions, regardless of distributions or the trust’s definition of income.
Can a non-grantor trust be a simple trust one year and a complex trust the following year?
Absolutely. Most trust instruments allow the trustee to distribute corpus to the income beneficiary or beneficiaries under certain conditions, for example if the beneficiary needs additional medical care or support. If that happens during the tax year, the trust will be treated as a complex trust for that year. But if in the following year no such distributions occur, then the trust will be again be a simple trust.
At John Schachter + Associates we help our clients plan for, implement, administer and report on, for all kinds of trusts. Let us know if we can help you!