Irrevocable Trust Question

[garyt]

My inlaws have some money in an Irrevocable Trust. My MIL had to go into memory care and FIL needs some money from the trust to live on. My BIL is the executor and my wife is the distributor.
So my BIL approves the money from the trust and it goes into my wife's bank account and she can then do whatever with it? And we have no tax consequences on this money? That's my main concern. Obviously I'm not educated on trusts.

 

[Dtail]

My inlaws have some money in an Irrevocable Trust. My MIL had to go into memory care and FIL needs some money from the trust to live on. My BIL is the executor and my wife is the distributor.
So my BIL approves the money from the trust and it goes into my wife's bank account and she can then do whatever with it? And we have no tax consequences on this money? That's my main concern. Obviously I'm not educated on trusts.

What type of Investment account is the Trust held in? TIRA/Roth/Taxable?

 

[garyt]

What type of Investment account is the Trust held in? TIRA/Roth/Taxable?

Taxable

 

[Spock]

Regardless of any tax issues, just for simpler tracking, set up a separate bill paying bank account for the in-laws. Transfer the $ to that account and pay the bills from it.

 

[garyt]

Regardless of any tax issues, just for simpler tracking, set up a separate bill paying bank account for the in-laws. Transfer the $ to that account and pay the bills from it.

We set it up in my wife's name? Or the inlaws?

 

[ERD50]

You need to look at the specifics of the trust. That is the determinant.

Also, your terms are questionable. There is no 'executor' of a trust as far as I am aware. They are called "trustees". I've never heard the term 'distributor' used. Maybe that is legit and I've just never seen it, but typically distributions are the job of the trustee/successor-trustee.

-ERD50

 

[garyt]

You need to look at the specifics of the trust. That is the determinant.

Also, your terms are questionable. There is no 'executor' of a trust as far as I am aware. They are called "trustees". I've never heard the term 'distributor' used. Maybe that is legit and I've just never seen it, but typically distributions are the job of the trustee/successor-trustee.

-ERD50

Right, Like I said I have no knowledge of these things. My wife used the term distributor but I've talked to her and she said that's just her way of describing it. Her brother is the Trustee as best I can tell, but she is also somehow involved. From what I'm hearing, he will give the money to her and she will then pass it on to her Dad. I just want to make sure there's no tax implications for us. My wife is a bit to easy going about it, like "I'm pretty sure there's no tax liability" And I'm like "pretty sure" doesn't cut it. I want absolute confirmation that we won't get hit as we will be managing income for ACA subsidy when I retire in May.

 

[Spock]

We set it up in my wife's name? Or the inlaws?

The account needs to be in the in-laws name with your wife able to use it as POA. Or as joint if necessary but only used for the in-laws affairs... never co-mingle funds.

 

[MichaelB]

Taxable

If the trust is a taxable account, all of the interest and investment income is taxable. The trust can declare the income and pay the tax, or it can distribute the untaxed income to beneficiaries and they have to declare and pay tax. The trustee makes that choice.

Tax rates for trusts are high, so most times the income is distributed pre-tax and the beneficiary declares the income.

Any distribution of principal is tax free.

 

[socca]

• the irrevocable trust's agreement specifies (1) the beneficiaries (who can receive distributions from the trust assets) and (2) the conditions under which distributions can be made. You will need to read the trust agreement.
• the trustee(s) authorize distributions. In this case, it sounds like your BIL is trustee.
• it's unlikely that your FIL is a beneficiary of the trust (this would make it a so-called intentionally-defective trust. If this is the case, see a lawyer who specializes in estate planning).
• if your wife is a beneficiary of the trust, then any distributions she receives will not be taxable income for her. However, you and your wife are limited to gifting $30k per year to your FIL without having to file a gift tax return. This is true regardless how much your wife receives from the trust ($1 or $1M - no difference).
• you may want to see an lawyer specializing in estate planning, especially if you think the trust is being mismanaged. For example, the trust should be filing annual tax returns.

This advice is worth what you paid for it. Good luck!

 

[garyt]

Thanks for the replies. I'm feeling better that we won't be responsible for any income. My BIL says the trust is set up to pay any taxes on earnings.

 

[Gill]

I don't entirely follow the arrangement or the personalities here, but you should know that distributions of principal or income from a trust carry out taxable income to the beneficiary. I noticed some contrary statements implying otherwise. You say the funds go into your wife's bank account. Is she a beneficiary of the trust?
Gill

 

[ERD50]

If the trust is a taxable account, all of the interest and investment income is taxable. The trust can declare the income and pay the tax, or it can distribute the untaxed income to beneficiaries and they have to declare and pay tax. The trustee makes that choice.

Tax rates for trusts are high, so most times the income is distributed pre-tax and the beneficiary declares the income.

Any distribution of principal is tax free.

Thanks for the replies. I'm feeling better that we won't be responsible for any income. My BIL says the trust is set up to pay any taxes on earnings.

MichaelB has it right. Your BIL's view is too narrow. He's not wrong, but it isn't complete info. BIL is correct that the trust pays the taxes now, but that may not be the case when distributions are made.

As MichaelB said, once distributions are made, and tax liability is generally allocated across those distributions. It can be allocated to the trust, but again, probably at a higher tax rate (but if that taxable income is small, it might fall into a lower bracket in the trust than if it was additional marginal income to the beneficiary). The trust tax forms (1041) will generate a K-1 for the beneficiaries. The K-1 documents if the taxable income is no longer the responsibility of the trust, and then it is the responsibility of the beneficiary. The IRS will get copies of those K-1's, so they know who is responsible. The IRS doesn't care if it is the trust or the beneficiary, they just need to know that one or the other is responsible.

-ERD50

 

[CaliKid]

You need to look at the specifics of the trust. That is the determinant.

Also, your terms are questionable. There is no 'executor' of a trust as far as I am aware. They are called "trustees". I've never heard the term 'distributor' used. Maybe that is legit and I've just never seen it, but typically distributions are the job of the trustee/successor-trustee.

-ERD50

+1

You really need to talk to a professional to determine what the trust allows and doesn't allow. The trustee can be liable for taking action against the terms of the trust. I would start with the attorney who wrote the trust but they sometimes do not want to represent the trustee due to "conflict of interest" so the trustee might need to get their own attorney. That attorney, almost certainly, can be paid by money in the trust. An experienced estate attorney (not a general practitioner) should be able to ascertain the language for distribution and discuss tax ramifications (if any) of the distribution.

 

[Gill]

MichaelB has it right. Your BIL's view is too narrow. He's not wrong, but it isn't complete info. BIL is correct that the trust pays the taxes now, but that may not be the case when distributions are made.

As MichaelB said, once distributions are made, and tax liability is generally allocated across those distributions. It can be allocated to the trust, but again, probably at a higher tax rate (but if that taxable income is small, it might fall into a lower bracket in the trust than if it was additional marginal income to the beneficiary). The trust tax forms (1041) will generate a K-1 for the beneficiaries. The K-1 documents if the taxable income is no longer the responsibility of the trust, and then it is the responsibility of the beneficiary. The IRS will get copies of those K-1's, so they know who is responsible. The IRS doesn't care if it is the trust or the beneficiary, they just need to know that one or the other is responsible.

-ERD50

Some clarification is needed here. If the trust mandates distribution of income, all income will be taxed to the beneficiary regardless of what the trustee does or decides. Also, distributions of principal are not always tax free and may carry out capital gains or income to the beneficiary.
Gill

 

[steelyman]

I’m glad to read ERD50’s mention of the possibility of K-1 generation as that has implications for the beneficiaries’ tax returns, not just 1041s for the trust at the Fed and State level.

 

[socca]

Some clarification is needed here. If the trust mandates distribution of income, all income will be taxed to the beneficiary regardless of what the trustee does or decides. Also, distributions of principal are not always tax free and may carry out capital gains or income to the beneficiary.

I googled this topic and Gill is correct. The type of irrevocable trust that I'm familiar with pays its own income taxes, making distributions tax-free to the beneficiaries (no K-1s issued). I'm not familiar with the other type of irrevocable trust. This is the danger of listening to SGOTI.

P.S. Just because you have to file a gift tax return doesn't mean that a gift tax will be due. If you and your wife haven't yet exceeded ~$22M in lifetime giving, you will probably not owe any tax for your gifts to your FIL.

 

[CaliKid]

I googled this topic and Gill is correct. The type of irrevocable trust that I'm familiar with pays its own income taxes, making distributions tax-free to the beneficiaries (no K-1s issued). I'm not familiar with the other type of irrevocable trust. This is the danger of listening to SGOTI.

P.S. Just because you have to file a gift tax return doesn't mean that a gift tax will be due. If you and your wife haven't yet exceeded ~$22M in lifetime giving, you will probably not owe any tax for your gifts to your FIL.

Plus the person making the gift is responsible for paying the gift tax.

 

[garyt]

I don't entirely follow the arrangement or the personalities here, but you should know that distributions of principal or income from a trust carry out taxable income to the beneficiary. I noticed some contrary statements implying otherwise. You say the funds go into your wife's bank account. Is she a beneficiary of the trust?
Gill

Yes, but I understand that the trust is set up to pay all taxes on earnings.

 

[garyt]

Some clarification is needed here. If the trust mandates distribution of income, all income will be taxed to the beneficiary regardless of what the trustee does or decides. Also, distributions of principal are not always tax free and may carry out capital gains or income to the beneficiary.
Gill

No mandate of distribution of income. Distributions will be made simply to cover FIL's shortfall in paying for the memory care and some spending money.

 

[aja8888]

Yes, but I understand that the trust is set up to pay all taxes on earnings.

Maybe you can ask to see the last few years worth of tax filings to make sure the trust has paid required taxes on the income?