A lot of people have questions about how taxes can impact estates, including taxes on trusts. In this post, we will provide some clarity, with an emphasis on taxes on capital gains.
Main Types of Trusts
Trusts essentially fall under three main categories. A simple trust is the most commonly used type of trust, and the structure is the most basic. The income that is generated by assets in the trust is distributed to the beneficiaries, but the principal or corpus remains in the trust.
Another type is the complex trust. Generally speaking, this is a trust that does not distribute all of the earned income that is generated in a given year. If parts of the principal are distributed, it would be a complex trust, and a trust that distributes assets to a charity is a complex trust.
The other category is the grantor trust. A “grantor” is a person that creates a trust. This grantor would pay the taxes on a grantor trust. With the other types of trusts, the trust as an entity would pay taxes directly.
Capital Gains Taxes on Trusts
There is a capital gains tax in the United States that is potentially applicable when appreciated assets are sold. The act of selling an appreciated asset is called “realizing a gain” in tax parlance.
Capital gains are broken up into short-term gains, and long-term gains. A gain is considered to be a short-term gain if it is realized less than a year after the acquisition. You guessed it, a long-term gain is a gain that it is realized more than a year after the assets were acquired.
Short-term gains on assets that are held by a trust are considered to be ordinary income for tax purposes. There is a 10 percent rate for income up to $2,750. The rate for income that is between $2,751 and $9,850 is 24 percent. The next bracket tops out at $13,450, and the rate is 35 percent. Ordinary income that exceeds this amount is in the 37 percent bracket.
Long-term gains for trusts are taxed at different rates. There is no tax on long-term gains that do not exceed $2,800. The rate is 15 percent for gains between $2801 and $13,700. For gains that exceed $13,700, the rate is 20 percent for trusts.
Capital Gains Rates for Individuals
Now that we are on the subject, we should share the capital gains situation for individuals so you can conduct a comparison. Short-term gains are taxed at your regular income tax level, plain and simple.
People that claim less than $41,675 in 2022 are exempt from long-term capital gains taxes. Filers that claim $41,676 up to $459,750 are taxed at a 15 percent rate. Those that pay taxes on more than $459,750 are in the 20 percent long-term capital gains bracket.
Estate Taxes
In closing, we should share some information about estate taxes that can impact assets that are held by a trust. The federal estate tax carries a 40 percent rate, and it is applicable on transfers that exceed $12.06 million. This figure is called the exclusion or credit. It should be noted that there is a marital deduction, so the tax is not applicable on transfers between spouses.
There are 12 states in the union that have state-level estate taxes, and Connecticut is one of them. This year, the Connecticut state estate tax exclusion is $9.1 million. This is the highest exclusion among the 12 states with estate taxes.
If taxation will be a source of concern, there are trusts that can facilitate tax efficient asset transfers. These would include the generation-skipping trust, the grantor retained annuity trust, the qualified personal residence trust, and the charitable lead trust, just to name a handful.
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As you can see, there are a lot of things to think about when you are planning your estate. There is no one-size-fits-all plan that is right for everyone, so personalized attention is key. This is exactly what you will receive when you work with our firm.
If you are ready to get started, you can schedule a consultation or Westport or Glastonbury, CT estate planning offices if you call us at 860-548-1000, and you can use our contact form to send us a message.
Mr. Florin is admitted to practice before the courts of the State of Connecticut and the State of New York. He is also a member of the American Academy of Estate Planning Attorneys, the National Academy of Elder Law Attorneys, the Connecticut Bar Association, and the Fairfield County Bar Association.