Withdrawing Trust Income To Reduce Taxes

By James DeMartino
April 2018


Have you ever heard someone say “it’s your after-tax returns that really matter?”  It’s true.  Tax consequences are always important, especially if you own investments held in an Irrevocable Trust.  In which case how you pay the taxes — or more accurately, who pays them — can significantly alter your bottom line.

An Irrevocable Trust typically has its own Tax ID, requiring you to file a separate tax return for your Trust each April, in addition to your own.  Tax rates for Trusts are steep.  Passage of the Tax Cuts & Jobs Act in December helped a tiny bit, but a Trust still enters the 37% tax bracket after only $12,500 of taxable income.

The most common method of avoiding the dreaded 37% bracket is for the Trustee to withdraw all of that year’s taxable income in December, and distribute it to the Trust’s beneficiaries.  If you do that, the Trust won’t owe any income tax at all, and the tax liability will be shifted to the beneficiaries — beneficiaries who will almost always pay taxes at a much lower rate. 

In the fairly common case in which a surviving spouse or surviving child is both the Trustee and the beneficiary, this strategy becomes a virtual no-brainer.  After all, it’s the same person who’ll pay the income tax, either way.  For example, if Jack’s Trust has $20,000 of net taxable income in 2018, and Jack doesn’t withdraw any money from the Trust, then Jack (as the Trustee) will owe the IRS almost $5,800.  On the other hand, if Jack is in the 24% bracket on his personal return, and if Jack withdraws that same $20,000, then the Trust won’t owe any taxes at all and Jack (as the beneficiary) will owe just $4,800.  That’s a big difference.

If you own an Irrevocable Trust, consulting with a qualified tax professional is essential.  So is keeping an eye on how much your Trust has earned in dividends and interest, as you approach year-end.  If you’d like to discuss this further at your next review, please let us know.

Commonwealth Financial Network does not provide tax advice. Tax preparation services offered through Gottfried & Somberg are separate and unrelated to Commonwealth.