How Dissolving a Trust Affects Taxes

Trusts are estate-planning tools, created to pass assets along to heirs without the hassle or expense of lengthy probate court proceedings. There are two basic types: irrevocable and revocable or living trust. An irrevocable trust generally cannot be changed, even by the person who set it up. A living trust can be changed by its creator at any time during his lifetime; it becomes irrevocable upon the creator's death. Both types of trust hold all the specified assets, although you can leave some assets out of a trust. Those, however, are subject to probate and estate taxes.

Disposition of Assets

A trust is not normally dissolved until all its assets are distributed. Once it has no assets, it has no tax liability. Individual heirs or beneficiaries generally are exempt from estate and other taxes on their inheritances, although there are some exceptions. A trust also can specify that the trust pay any applicable taxes before assets are passed out.

Living Trust Dissolution

The creator or grantor of a living trust can dissolve it at any time. When that is done, the assets of the trust revert to the name of the grantor. In other words, deeds, mortgages, securities, savings accounts or other assets are put back in the name of the grantor. The grantor then assumes any tax obligation for those assets. There should be no tax on the transactions unless the trust owed taxes at the time of the transfer.

Like Closing a Business

Either a living trust or an irrevocable trust can be dissolved if the trustee, usually the grantor in a living trust, and all beneficiaries agree or if a court order is obtained for some reason to dissolve the trust. The Internal Revenue Service treats dissolving a trust like closing a business. Tax returns have to be filed showing how assets were disposed of. Any taxes due have to be paid when the trust is dissolved.

Trust Provisions

Trusts are created under state laws, which vary slightly among states. They also set out terms and conditions for disposition of assets and a trust document could, for instance, specify tax responsibilities. In general, the trustee will be responsible for seeing that any returns are filed and taxes are paid before the trust is dissolved.

About the Author

Bob Haring has been a news writer and editor for more than 50 years, mostly with the Associated Press and then as executive editor of the Tulsa, Okla. "World." Since retiring he has written freelance stories and a weekly computer security column. Haring holds a Bachelor of Journalism from the University of Missouri.