Student Question from: Harry F.
Course:  Estate Planning – Taxation of Trusts and Estates

Student Question:

In the statement below, regarding complex trusts, it states, “If income from the trust is distributed, it is taxed to the beneficiary; if accumulated, the tax is paid by the trust.”  So, would double taxation occur if a trust accumulates income (pays taxes) then in later yrs distributes it (beneficiaries pay taxes)?

Instructor Response:

Hi Harry! 

Good question here.  There is no double taxation: let me explain why.  When the irrevocable trust pays income tax on trust income, the income is not subject to income tax in future distributions to the beneficiary.  In essence, future distributions of previously taxed income are distributed income tax free to the beneficiary.

For example, assume that an irrevocable trust has taxable income from CD interest of $20,970 in 2013.  Further assume that the trust accumulates (retains) the interest income and does not pay it to beneficiaries in 2013.  The trust will pay income tax of $7,050 on taxable income of $20,950.  In 2014 the trust pays the interest income to the beneficiaries.  The beneficiaries receive the income on an income tax free basis.