Family Trusts & Taxes

A family trust is a legal entity created to hold assets of a family, such as a business or an estate. Those with an interest in the asset, called settlers, designate a trustee to oversee the assets, such as operating the business or distributing an estate. Those who benefit are beneficiaries. A trustee does not have to be a family member, although most are. A family trust can provide some tax advantages by controlling distributions, spreading them over several years, for instance.

State Laws

Trusts are set up under state laws and regulations dealing with operations and distribution of assets and income and state taxes will vary. Parents often set up family trusts to manage assets for children or family members who may lack the experience to handle them, to avoid probate upon death of a trust creator or grantor and to avoid or minimize the impact of estate taxes.

Federal Taxes

State taxes on family trusts vary, but federal laws require family trusts to pay taxes on income it keeps but not on any that is distributed. A trust that earns $50,000 and distributes it all to trust beneficiaries pays no income tax. The beneficiaries pay income taxes on funds given to them.

Trust Distribution

A family trust is a way to provide income for family members over a long time. Some parents use a trust to guarantee children some income. A family trust, for instance, can pay beneficiaries from trust income indefinitely or can distribute assets so personal income taxes are spread over several years, rather than being lumped into a single year.

Bypass Trust

A married couple can set up a family trust as a "bypass." Family assets pass to a family trust on the death of one spouse with a provision to guarantee funds for the life of the surviving spouse. On the death of the second spouse, trust assets pass directly to the family beneficiaries without being taxed.

Other Taxes

A trust must pay taxes on any property it owns and applicable taxes on any business it operates. It also may have to withhold income taxes on employees to be paid to the federal or state government on behalf of the employee. These taxes do not directly affect the trust beneficiaries.

Legal Advice

Because of the many variables in state laws and questions about federal estate taxes, it is always best to consult a lawyer. A lawyer will have to actually draft the agreement to create the trust and it may have to be filed with a court or clerk.

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