What Are the Tax Implications of Different Trust Structures?
Trusts are a valuable tool for managing assets, but each type has different tax implications. Tax considerations vary depending on whether the trust is revocable or irrevocable, grantor or non-grantor, or charitable. Each influences income, gift, and estate taxation, as well as potential benefits for beneficiaries. When choosing a trust, it's important to focus on how it will impact your current and future tax liabilities.
Addressing the tax implications of trusts can be challenging, but careful planning allows you to make informed decisions for your assets and beneficiaries. At Thooft Law LLC, we work with individuals and families to evaluate different trust structures and how they impact income, gift, and estate taxes.
Located in Eagan, Minnesota, our firm provides services to clients throughout the Twin Cities area, including Minneapolis and Saint Paul, and is dedicated to helping you structure trusts that align with your financial goals. Contact our firm today to discuss how we can assist with your trust planning.
Income Tax Considerations for Revocable and Irrevocable Trusts
A key factor in trust taxation is whether the trust is revocable or irrevocable. Revocable trusts allow the grantor to retain control over assets during their lifetime. Since the grantor maintains control, all income generated by the trust is reported on the grantor’s personal income tax return.
Interest, dividends, and capital gains are taxed at the grantor’s individual tax rate. Irrevocable trusts, by contrast, transfer control of the assets to the trust. Once the trust is funded, the grantor typically loses ownership and management rights. The trust becomes a separate taxpayer, responsible for reporting and paying taxes on any income it retains.
For irrevocable trusts, higher incomes can trigger compressed tax brackets, meaning the trust may reach the highest federal income tax rate at a much lower income threshold than an individual would.
At Thooft Law LLC, we strive to help you review these distinctions to help you understand how different trust structures may affect their income tax obligations. We often advise clients to consider how much income the trust is expected to generate.
Gift and Estate Tax Implications
Trusts can also impact gift and estate taxes, especially when assets are transferred to an irrevocable trust. Contributions to irrevocable trusts are generally treated as completed gifts. This can reduce the grantor’s taxable estate, potentially lowering estate taxes owed at death.
At the same time, gift tax rules may apply when the trust is funded, so you should consider annual exclusions and lifetime exemptions. Some strategies you should discuss with your attorney include:
Using the annual gift tax exclusion to fund a trust without triggering immediate gift taxes. For 2026, this allows gifts of up to $18,000 per recipient per year to pass tax-free.
Applying the lifetime gift exemption to transfer larger assets while using part of the individual exemption. This can reduce the taxable estate and provide long-term planning advantages.
Structuring contributions over several years to manage both gift and estate tax impacts efficiently.
For revocable trusts, the grantor retains ownership of the assets, which means they remain part of the taxable estate. While revocable trusts provide flexibility and can simplify the transfer of assets at death, they don’t reduce estate taxes. Comparing revocable and irrevocable trusts side by side often helps clients prioritize their estate planning goals while managing tax liability.
Grantor vs. Non-Grantor Trusts
Trusts are also distinguished by whether they’re grantor or non-grantor for income tax purposes. Grantor trusts are generally taxed to the grantor. Income, deductions, and credits pass through to the grantor’s individual tax return. This can simplify reporting and allows grantors to offset other taxable income with trust deductions. Many revocable trusts are classified as grantor trusts since the grantor retains significant control.
Non-grantor trusts, however, are separate tax entities. The trust itself may pay taxes on the income it retains, while the income distributed to beneficiaries is taxable to them. This structure requires careful planning to manage tax consequences for both the trust and beneficiaries.
At Thooft Law LLC, we can help you determine how distributions can reduce your overall taxes and provide financial support to your beneficiaries in a tax-efficient manner.
Charitable and Special-Purpose Trusts
Charitable and special-purpose trusts can provide unique tax advantages. Charitable remainder trusts, for example, allow the grantor to receive income during their lifetime and donate the remaining assets to a qualified charity. The grantor may receive an income tax deduction for the charitable portion and avoid capital gains taxes on their appreciated assets.
Generation-skipping trusts also allow you to transfer your wealth to your grandchildren or younger generations while potentially reducing your estate taxes over multiple generations. Since the assets can bypass one generation for estate tax purposes, you may be able to preserve more wealth for your long-term beneficiaries.
Other specialized trusts, such as special needs trusts, provide for a beneficiary’s care without disqualifying them from government benefits. While the tax treatment varies depending on whether the income is distributed or retained, these trusts combine financial planning with social considerations.
At Thooft Law LLC, we emphasize timing and distribution strategies when establishing these trusts. Coordinating when and how income or principal is distributed can have a meaningful impact on both the trust’s tax liability and the beneficiaries’ tax exposure.
Practical Considerations and Planning Tips
Tax planning for trusts is nuanced, and it can be challenging to understand the specific factors if you lack an understanding of how trusts are taxed. At Thooft Law LLC, we strive to advise you on your best options for using trusts as tax planning entities. Several practical tax planning factors you should consider include:
Choosing between revocable and irrevocable structures based on their level of control, flexibility, and income tax impact.
Estimating income generated by the trust and how it’ll be taxed if retained or distributed.
Coordinating trust distributions with your beneficiaries’ tax brackets to reduce total taxes paid.
Utilizing gift and estate tax exemptions strategically to shift your wealth efficiently.
Considering charitable or special-purpose trusts to achieve your financial and personal goals.
By addressing these factors, you can structure a trust that meets your needs while minimizing unnecessary tax burdens. Our attorneys will help you review the implications of Minnesota state taxes, which can differ from federal rules, to make sure you and your family understand the local tax environment.
Contact an Experienced Estate Planning Attorney in Minnesota Today
Trust planning is an ongoing process that benefits from careful consideration and thoughtful attention to tax implications. At Thooft Law LLC, we can help you evaluate your options and develop strategies for different trust structures that fit your financial and estate planning goals.
Located in Eagan, Minnesota, we serve clients across the Twin Cities, including Minneapolis, St. Paul, Eagan, Woodbury, Maplewood, Roseville, Fridley, and Inner Grove Heights. Contact our firm today to schedule a consultation and start planning your trusts with clarity and confidence.