A living trust doesn't die when its owner does. Once the grantor, or trust creator, dies, a successor trustee takes control of the assets. The successor runs the trust according to the grantor's written directives. That includes paying the taxes as long as the trust is still in existence. That may be just long enough to distribute the assets, but some trusts continue for years.
The tax return for trusts and estates is Form 1041. If the trust has any taxable income, or $600 of gross income as of 2014, the trustee has to file a return. She also files if one of the beneficiaries is a resident alien. The trust's first year as a taxpayer starts the day after the grantor dies. If that's May 12, for example, the 1041 reports any income the trust assets earn from May 13 through the end of the year.
Once the grantor dies, the trustee has to apply to the IRS for a taxpayer identification number. This identifies the trust as an individual taxpayer, the same way your Social Security number identifies you. The trustee can apply at the IRS website for a number. The trustee then tracks each year's income and expenses and calculates the tax accordingly. Any money distributed to the beneficiaries counts as a tax deduction for the trust.
If the trustee expects the trust to owe $1,000 or more in tax on top of any withholding, she may have to pay estimated tax. Estimated tax works like withholding for self-employment and investment income. For the 2014 tax year, the trustee can make one estimated payment in April, or four quarterly payments in April, June September and next January. The trustee uses Form 1041-ES to calculate and submit the estimated payments.
The Tax Bite
As of 2014, a single taxpayer earning $20,000 pays a top income-tax rate of 15 percent. A trust earning that much pays 39.6 percent. That's an incentive to distribute more money to beneficiaries. Distributions lower the trust's taxable income and the beneficiaries usually pay lower rates than the trust. Some trustees pay extra money to the beneficiary in the lowest tax bracket to minimize the total taxes.