Trusts and estates continue to benefit from the reduced tax rates established under the Tax Cuts and Jobs Act of 2017. Income tax rates for trusts and estates for taxable years beginning after December 31, 2018, and continuing through December 31, 2025, range from 10% to 37%.
If an estate or trust generates more than $600 in annual gross income, a Form 1041, Income Tax Return for Estates and Trusts, must be filed. Furthermore, a fiduciary is also generally required to file a Form 1041 for any domestic trust that has any taxable income for the tax year.
The tax rate schedule for trusts and estates in 2023 is as follows:
| 2023 Federal Estate and Trust Income Tax Rates | ||
|---|---|---|
| If taxable income is: | The tax is: | |
| Not over $2,900 | 10% of taxable income | |
| Over $2,900 but not over $10,550 | $290 plus 24% of the excess over $2,900 | |
| Over $10,550 but not over $14,450 | $2,126 plus 35% of the excess over $10,550 | |
| Over $14,450 | $3,491 plus 37% of the excess over $14,450 | |
In the absence of future legislation, for taxable years beginning after December 31, 2025, these rates will sunset, and tax rates and brackets will revert back to prior levels, with increased rates and the top bracket being taxed at 39.6%.
Capital Gains Tax
For trusts and estates, income from assets held 12 months or less (short-term capital gains) and non-qualified dividends are taxed as ordinary income. Qualified dividends and capital gains on assets held for more than 12 months are taxed at a lower long-term capital gains rate.
For trusts and estates during 2023, a 15% capital gains tax rate applies to adjusted capital gains of more than $3,000 and up to $14,650, with capital gains over $14,650 being taxed at a 20% rate.
Section 645 Election
A common estate planning document taxpayers often use is known as a revocable living trust. In many cases, the revocable living trust serves as the primary estate planning document for the grantor, with the grantor’s Last Will serving primarily to “pour over” any probate assets to the revocable trust upon the grantor’s death. When implemented correctly during the grantor’s life, the revocable trust may allow the grantor’s estate to bypass the probate process entirely.
Where the trust is a “qualified revocable trust” as defined under Internal Revenue Code Section 645, the trustee of the revocable trust and the executor of the estate can use a Section 645 election to treat the trust as part of the estate for federal income tax purposes. In addition to the benefit of combining the trust and estate into a single income tax return, this election also allows the estate to select a fiscal year end, as opposed to a calendar year end. Depending on the date of the decedent’s death, this may allow the trustee and executor the ability to defer income and avoid the expense of multiple tax filings.
Tax Considerations upon Death of Taxpayer
When a taxpayer dies without trusts or other specialized planning, his or her estate becomes a separate legal entity for federal income tax purposes. In such an event, the estate must obtain its own federal tax identification number, and any income attributable to the decedent’s estate will be subject to the estate income tax rates described above and the rules described in Subchapter J of the income tax provisions of the Internal Revenue Code.
Similarly, for a taxpayer with a revocable living trust, upon the grantor’s death, such trust typically becomes irrevocable, and the trust must obtain a separate tax identification number. Additionally, any income earned by a trust or estate after the decedent’s death will be subject to trust and estate income tax rates and rules.
In addition to the income tax filing requirements for trusts and estates, there may also be a need to file an IRS Form 706, Estate Tax Return for the decedent’s estate. Filing of a federal estate tax return is required when a taxpayer’s gross estate plus adjusted taxable gifts exceed the federal estate tax exemption. When there is a surviving spouse, it is often beneficial to file an estate tax return for the primary purpose of electing portability of the decedent’s remaining estate tax exemption. Transferring (something referred to as “porting”) of the deceased spouse’s unused exemption amount to the surviving spouse provides for future opportunities for estate and gift tax savings.
Proper Tax Planning Requires Careful Consideration
For trustees and executors, it is important to review the tax provisions of the decedent’s wills and trusts with a qualified tax advisor to ensure you are administering the trust or estate in a manner that will achieve accurate tax results for the beneficiaries of the trust or estate. Careful attention and thought should be considered in preparing income tax returns for trusts and estates, as fiduciaries can be held personally liable for mistakes and erroneous tax reporting positions.
