Q: I am a 76-year-old widower. My estate is not large enough to create an estate tax payment. I have about $4 million of total assets, which include two investment properties. I also own my house free and clear. I was advised to set up a “living trust” for my assets to allow me to provide for my children and also perhaps for my grandchildren. I am to be the trustee of this trust for as long as I can, with my oldest daughter named as a successor trustee. I do not want to complicate my tax situation and I would like you to confirm that I will be able to continue to report all income on my own tax return.
A: I have not seen the trust documents but your description sounds like a very typical “grantor” trust for income tax purposes. The grantor is the person who establishes the trust, in this case you, and if certain powers are retained over trust property the tax law classifies the trust as a grantor trust.
The practical result of grantor trust status is that you are treated as the owner of all trust assets for tax purposes. This can allow you to continue to report all income and expenses associated with your property on your personal tax return.
The tax law has a variety of provisions (these “power” items) that can create a grantor trust. The deemed owner can even be someone other than the grantor. That complicates the tax filing a bit, but what you describe is the garden-variety (simple) living trust arrangement.
In your situation there is only one person (you) treated as the grantor. This means that you are the only party who has to report tax items associated with trust assets.
In your simple structure, no trust tax return is required where all parties that may have to report to the IRS have your name, address and social security number as the reporting party. You would get forms to report interest, dividends, asset sales, mortgage interest, property taxes, and so on.
When the parties that report this to the IRS have your tax identification number, which they already have, you do not need to file a trust income tax return.
At some point your trust may change – for example, if you pass away or even if you become incapacitated and someone has to take over as a successor trustee. At that point the trust itself may become a tax reporting entity. But for now you don’t need to change any tax reporting.
Q: I found an item that you wrote that said that inheritances were not income. I was glad to hear that but in addition to inheriting my mother’s house and her car, I also received $50,000 life insurance proceeds. I did not know she had a policy and I was told that I was the named beneficiary of the policy. I don’t know if this technically qualifies as an inheritance and so I wonder if I will have to report the $50,000 as income. I also got her IRA account, again because I was the named beneficiary.
A: Inheritances are tax free because the tax law says so. Life insurance proceeds are also tax free, again because the law says so. So both the inheritance and the insurance proceeds will not be income to you.
The IRA is a different story. It may seem to be like the life insurance because the beneficiary designation is why you received it. But your ability to exclude the item is not because of a beneficiary designation but instead because the law has a specific exclusion.
There is no specific exclusion for an inherited IRA. The tax law instead calls this “income in respect of a decedent IRD.” An odd term but it means that the party who receives distributions after death must pay tax on the distributions.
You didn’t provide details on the IRA, such as whether your mother was taking required distributions. But in general you will be required to withdraw all IRA funds within 10 years. You could take it all immediately, but there is a limit on how long you can stretch the distributions.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at email@example.com.