Trust mechanisms vary, but experts say that choosing the right structure is essential to mitigating and managing tax obligations. Pennsylvania families that create trusts to give their members financial support or make it easier to plan their estates may find that including specific provisions can also help ensure that these tools serve their intended purpose.
According to one source, family trusts can be divided into two important categories: grantor and non-grantor trusts. A grantor is the person who creates a trust, and grantor trusts have to meet one of a specific list of requirements, such as permitting the grantor to remove assets from a trust. Other powers, such as drawing trust income, holding trust interest entitlements or retaining administrative rights, can also qualify a trust for grantor status.
A trust's grantor status determines which tax rules apply. For instance, grantor trusts don't need to file separate returns as long as the grantor includes trust income on their personal tax return. Non-grantor trusts need to file separate returns as entities, and depending on who holds the rights to trust income, the trust or its beneficiaries may also have to pay income taxes.
Investment and estate planning tools like trusts have numerous benefits, but they're not without their potential disadvantages. Because trust income is often taxable, grantors who create certain types of structures for their families may increase their overall tax burdens. It's wise for investors and estate planners to learn how federal and state laws deal with trust assets and income prior to creating any estate structure. There are many ways to minimize tax obligations and still plan an estate that satisfies most needs, but capitalizing on these methods may require in-depth situational research.