Trusts, Estates, and Taxes Explained: Simple Guide to Income Tax, Beneficiary Rules, Gift Tax, Estate Tax, and GSTT (2025 Update)

Q1. Who pays tax on trust or estate income?

Either the trust/estate itself or its beneficiaries. If income is kept inside, the trust/estate pays. If it’s distributed, the beneficiaries usually pay.

Q2. Do trusts and estates use the same tax rates as people?

Not exactly. They use special brackets, and the top rate (37%) kicks in at just over $15,000 of income — much faster than for individuals.

Q3. What’s a “simple trust”?

One that must give out all its income every year, doesn’t give away the principal, and doesn’t donate to charity.

Q4. What’s a “complex trust”?

Any trust that isn’t “simple.” It can hold back income, give away principal, or make charitable gifts.

Q5. What’s a “grantor trust”?

A trust where the person who set it up (the grantor) is still treated as the owner for tax purposes. The IRS ignores the trust and taxes the grantor directly.

Q6. What makes a trust a grantor trust?

If the grantor keeps control (like the right to revoke, or income can be used for their spouse or dependents), then it’s a grantor trust.

Q7. Are all revocable trusts grantor trusts?

Yes. If the grantor can change or cancel it, all income is taxed to them.

Q8. Who are income vs. remainder beneficiaries?

Income beneficiaries get yearly earnings (like interest/dividends). Remainder beneficiaries get what’s left when the trust ends.

Q9. When must an estate file a tax return?

If it earns $600 or more in a year.

Q10. When must a trust file a tax return?

If it has any taxable income or $600+ of gross income.

Q11. Which IRS form is used for trusts and estates?

Form 1041.

Q12. When is Form 1041 due?

By the 15th day of the 4th month after the tax year ends (April 15 for calendar-year trusts).

Q13. Can estates use a fiscal year?

Yes. They can pick a year that ends any month within 12 months after death.

Q14. Can trusts use a fiscal year?

Usually no — most must use a calendar year (Jan–Dec).

Q15. Is alternative minimum tax (AMT) applied?

Yes. Trusts and estates calculate AMT just like individuals.

Q16. What’s the difference between “principal” and “income”?

Principal is the main property (like stocks, house). Income is the return it produces (like dividends, rent).

Q17. Is selling stock principal or income?

It’s principal. The gain belongs to the estate/trust itself, not the income beneficiary.

Q18. Who decides what counts as income vs. principal?

State law, often based on the Revised Uniform Principal and Income Act (RUPIA).

Q19. Can a trust distribute capital gains to beneficiaries?

Usually no — capital gains are principal, so the trust pays tax on them.

Q20. Do trusts and estates get a standard deduction like individuals?

No. Instead, they get a small exemption ($600 estate, $300 simple trust, $100 complex trust).

Q21. Are trustee or executor fees deductible?

Yes, they can deduct reasonable fees.

Q22. Are funeral expenses deductible on Form 1041?

No. They are deductible on the estate tax return (Form 706), not on the income tax return.

Q23. Can depreciation be deducted?

Yes. If the trust earns income from property, depreciation is split between trust and beneficiaries.

Q24. Can medical bills of the decedent be deducted on Form 1041?

No, they go on the decedent’s final personal tax return.

Q25. Are charitable contributions deductible?

Only if the trust document allows it. And they are not limited by adjusted gross income (AGI) like for individuals.

2. Beneficiary’s Taxable Income

Basics of Beneficiary Taxation

Q1. Do beneficiaries pay tax on money they receive from a trust?

Yes, if the money comes from the trust’s taxable income. The trust passes the tax burden to the beneficiary through a Schedule K-1.

Q2. Do beneficiaries always pay tax on everything they receive?

No. They only pay on the portion of trust income classified as taxable under the IRS’s “distributable net income” (DNI) rules.

Q3. What is DNI in simple words?

Think of DNI as the maximum amount of trust income that can be taxed to beneficiaries. It’s a limit so they don’t pay more than what the trust actually earned.

Q4. If the trust distributes more than DNI, do beneficiaries pay on the excess?

No. Any amount above DNI is considered a return of principal (corpus) and is tax-free to the beneficiary.

Q5. How are simple trust beneficiaries taxed?

They are taxed on the income the trust must distribute each year — even if they didn’t actually receive it.

Q6. How are complex trust beneficiaries taxed?

They are taxed on what is required to be distributed plus any additional discretionary distributions, but still limited by DNI.

Q7. What happens if a trust earns $10,000 but is required to distribute $6,000?

The beneficiary is taxed on $6,000, and the trust pays tax on the $4,000 it keeps.

Q8. What if the trust’s document says “all income must be distributed”?

That’s a simple trust rule. The beneficiary will be taxed on all the trust’s taxable income, whether or not the trustee actually distributes it.

Q9. Do beneficiaries pay tax on the same “type” of income the trust earned?

Yes. If the trust got dividends, the beneficiary reports dividends. If the trust got tax-exempt interest, the beneficiary reports tax-exempt interest.

Q10. Can beneficiaries receive tax-exempt income?

Yes. For example, if part of the trust’s income is municipal bond interest, the beneficiary gets that portion tax-free.

Q11. What about capital gains?

Usually capital gains stay in the trust and are taxed to the trust — unless the trust document or state law allocates them to beneficiaries.

Q12. So if the trust sells stock and keeps the gain, do beneficiaries pay?

No. The trust pays tax, because capital gains usually belong to the trust’s principal, not its income.

Q13. Example: A trust earns $12,000, requires $6,000 distribution, and has DNI of $12,000. What’s taxable to the beneficiary?

$6,000. The trust keeps $6,000 and pays tax on it.

Q14. Example: A simple trust earns $10,000 and must distribute it all. The DNI is $10,000. What’s taxable to the beneficiary?

The entire $10,000, even if the trustee didn’t physically distribute it by year-end.

Q15. Example: A trust distributes $20,000 to 5 beneficiaries, but DNI is $60,000. How much does each report?

$12,000 each ($60,000 ÷ 5). The law spreads DNI across them, regardless of how much cash they got.

Q16. How do beneficiaries know what to report?

They receive a Schedule K-1 (Form 1041) from the trustee, showing their share of income, deductions, and credits.

Q17. What if the K-1 says I received “interest income”?

That means you report it as interest income on your personal return — the trust’s income character carries over to you.

Q18. Do beneficiaries ever report deductions from the trust?

Yes. They can sometimes claim items like depreciation or excess deductions if passed through.

Q19. Can beneficiaries get a credit through a trust?

Some credits (like foreign tax credits) may flow through, but many personal credits (like child tax credit) do not.

Q20. What if the trust distributes more than its income?

Beneficiaries only report taxable income up to DNI. The extra is treated as tax-free return of principal.

Q21. What if the trust distributes less than DNI?

Only the distributed portion is taxed to the beneficiaries; the trust pays tax on the rest.

Q22. What if an estate distributes property instead of cash?

The beneficiary’s taxable income is based on DNI, not on the fair market value of property received.

Q23. What if I receive a specific bequest, like my grandmother’s ring?

Specific bequests given in a few installments are not taxable income — they’re treated as inheritance, not earnings.

Q24. Do estimated tax payments made by a trust ever pass through to beneficiaries?

Yes. A trustee can elect to treat payments as made by the beneficiary, usually in the estate’s final year.

Q25. Do beneficiaries get the qualified business income deduction (QBID) through trusts?

Yes, trusts and estates can pass through QBID to beneficiaries if they earn qualified business income.

3. Gift Tax

Basics of Gift Tax

Q1. What is a gift for tax purposes?

A gift is when you give someone money or property without expecting to get paid back.

Q2. Who pays gift tax — the giver or the receiver?

The giver (donor) pays any gift tax, not the person receiving it.

Q3. Do small gifts get taxed?

No. The first $19,000 per person per year (2025) is tax-free.

Q4. Is the $19,000 rule per donor or per recipient?

Per recipient. You can give $19,000 to as many people as you want each year.

Q5. What if I give more than $19,000 to someone?

The extra counts against your lifetime exemption before you owe tax.

Q6. What is the lifetime exemption?

It’s the total amount you can give away tax-free during your lifetime, above annual exclusions. For 2025, it’s $13.99 million.

Q7. Does the lifetime exemption apply to both gift and estate taxes?

Yes. Gifts during life reduce how much is tax-free at death.

Q8. What’s the maximum gift tax rate?

40% on taxable gifts above $1 million (after exclusions/exemptions).

Q9. Do small gifts like birthday or holiday presents need reporting?

No, as long as they’re under $19,000 per person per year.

Q10. Is there a special form for gift taxes?

Yes. You use Form 709 (Gift Tax Return) if your gifts exceed the annual exclusion.

Q11. Are payments for someone’s tuition a gift?

Not if you pay the school directly. Tuition payments are fully excluded.

Q12. Are payments for someone’s medical bills a gift?

Not if you pay the hospital or doctor directly. Those are excluded too.

Q13. What if I give money to someone so they can pay their tuition or hospital bill themselves?

Then it’s a taxable gift — you must pay the provider directly to qualify for the exclusion.

Q14. Are political contributions taxable gifts?

No, political donations are not considered gifts for tax purposes.

Q15. Are support payments (like child support or alimony) gifts?

No. They are legal obligations, not gifts.

Q16. What is gift splitting?

Married couples can agree to treat one spouse’s gift as if both gave half.

Q17. Example: If a husband gives his daughter $38,000, how does splitting work?

It’s treated as $19,000 from each spouse, so no taxable gift.

Q18. Do both spouses have to file if they split gifts?

Yes. Each files a Form 709, or one spouse signs the other’s return to consent.

Q19. Can gift splitting apply if one spouse is a nonresident alien?

No. Both must be U.S. persons.

Q20. Is there a limit to spousal gifts?

No, if the spouse is a U.S. citizen. If not, the limit is $190,000 in 2025.

Q21. If I give someone property, what’s their tax basis?

They take your basis (what you paid), adjusted if you paid gift tax.

Q22. Example: If you give land worth $98,000 that you bought for $63,000, what happens?

The recipient’s basis is your $63,000 plus some of the gift tax you paid.

Q23. What if I lend money to a family member with no or low interest?

The IRS may treat the “missing interest” as a gift.

Q24. Are small family loans ignored?

Yes, if the total loans are under $10,000. Larger loans may require imputed interest.

Q25. Do gifts from foreigners need reporting?

Yes. If a U.S. person receives more than $100,000 from a foreign individual/estate (or $19,570 from a foreign corporation/partnership), it must be reported on Form 3520.

4. Estate Tax

Basics of Estate Tax

Q1. What is the estate tax?

It’s a tax on the transfer of a person’s property when they die.

Q2. Who pays estate tax — the estate or the heirs?

The estate pays first, out of estate assets, before heirs get their share.

Q3. Do all estates pay estate tax?

No. Only very large estates above $13.99 million (2025) are taxable.

Q4. What if the estate is below $13.99 million?

No federal estate tax is due, but heirs may still owe income tax on certain items they later receive.

Q5. Is the estate tax separate from state inheritance taxes?

Yes. Some states have their own death or inheritance taxes in addition to the federal estate tax.

Q6. What goes into the “gross estate”?

Everything the person owned or had rights to — cash, houses, stocks, retirement accounts, life insurance (if controlled), and business interests.

Q7. Are joint accounts included?

Yes. Generally the full value is included, unless you can prove the co-owner contributed money.

Q8. How are married couples treated with joint property?

Half of jointly owned property is included in the deceased spouse’s estate, regardless of who paid.

Q9. Are life insurance proceeds taxed in the estate?

Yes, if the decedent owned the policy or could change the beneficiary.

Q10. What about gifts made shortly before death?

Gifts within 3 years of death may be pulled back into the estate (especially life insurance transfers).

Q11. Can funeral costs reduce the estate tax?

Yes, they are deductible on the estate tax return.

Q12. What about debts the person owed?

Yes, valid debts are deductible (like mortgages, credit cards, medical bills).

Q13. Can charitable bequests reduce the estate?

Yes, gifts to qualified charities are deductible in full.

Q14. What about property left to a spouse?

Unlimited deduction if the spouse is a U.S. citizen. If not, it’s capped at $190,000 in 2025 unless a special trust (QDOT) is used.

Q15. What is the “applicable credit amount” (ACA)?

A credit that shields up to $13.99 million (2025) of estate transfers from tax.

Q16. What is “portability”?

If one spouse dies and doesn’t use all their exemption, the unused portion can be transferred to the surviving spouse.

Q17. Example: Husband dies using $3M of his $13.99 M exemption. What does the wife have?

She gets her own $13.99 M plus his unused $10.61M = $24.98M total exemption.

Q18. Does portability happen automatically?

No. The estate must file Form 706 to elect portability, even if no tax is due.

Q19. How are assets valued for estate tax?

At their fair market value on the date of death, or 6 months later if the executor elects the alternate valuation date.

Q20. What is a “stepped-up basis”?

Heirs usually get property valued at its date-of-death value. This often reduces future capital gains tax if they sell.

Q21. Example: Mom bought land for $100,000, worth $600,000 when she dies. What’s the heir’s basis?

$600,000 — the “stepped-up” value.

Q22. Can heirs increase the step-up beyond what’s reported on the estate return?

No. The estate must file Form 8971 to lock in the reported value.

Q23. When is the estate tax return (Form 706) due?

Within 9 months of death, with an optional 6-month extension.

Q24. What if the estate doesn’t have cash to pay?

The IRS may allow installment payments, especially if most of the estate is a closely held business.

Q25. What happens if the executor doesn’t pay the tax?

The IRS can hold the executor personally liable, but they can recover funds from beneficiaries if needed.

5. Generation-Skipping Transfer Tax (GSTT)

Basics of GSTT

Q1. What is the GSTT?

It’s an extra tax on transfers of money or property that “skip” a generation — like giving assets directly to your grandkids instead of your kids.

Q2. Why does this tax exist?

To stop wealthy families from avoiding estate tax at each generation by skipping straight to grandchildren.

Q3. Who pays the GSTT?

It depends — the donor pays for direct gifts (direct skips), the recipient pays for taxable distributions, and trustees pay for taxable terminations.

Q4. Is GSTT in addition to gift or estate tax?

Yes. It’s a separate layer of tax on top of regular gift or estate tax.

Q5. What is the GSTT rate?

The maximum estate/gift tax rate — 40% in 2024.

Q6. What’s a “skip person”?

Someone two or more generations below you, like a grandchild, or a non-relative more than 37½ years younger.

Q7. Is my child a skip person?

No, only grandchildren, great-grandchildren, etc.

Q8. What about a trust?

A trust is a skip person if all its beneficiaries are skip persons.

Q9. If I give to my grandchild, is GSTT automatic?

Yes, unless you use your GST exemption (see below).

Q10. What if I give to a relative close in age, like a niece?

The law measures by generations. A niece is one generation below you, so not a skip person.

Q11. What is a “direct skip”?

A transfer subject to estate or gift tax made directly to a skip person, like giving your grandchild $500,000 outright.

Q12. What is a “taxable distribution”?

A payment from a trust to a skip person (grandchild) that isn’t a direct skip.

Q13. Who pays tax on a taxable distribution?

The beneficiary (the grandchild, in this case).

Q14. What is a “taxable termination”?

When non-skip people’s interests in a trust end (like when your child dies) and only skip people (grandchildren) are left.

Q15. Who pays tax on a taxable termination?

The trustee, from the trust assets.

Q16. How much can I give free of GSTT?

You have a $13.99 million lifetime exemption (2025), separate from the annual exclusion.

Q17. Can couples combine their exemptions?

Yes, with gift splitting, they can shield up to $27.98 million (2025).

Q18. Do annual exclusions apply to GSTT?

Yes. Each person can give $19,000 (2025) per year per donee, even to a grandchild, without triggering GSTT.

Q19. What about paying tuition or medical bills directly for a grandchild?

Those payments are excluded from both gift tax and GSTT.

Q20. Does appreciation after I allocate my exemption get taxed?

No. Once you allocate GST exemption to property, all future growth is also exempt.

Q21. Example: I give my grandson $100,000 in 2025. What happens?

The first $19,000 is excluded. The remaining $81,000 reduces your lifetime GST exemption. No GSTT is due if you have exemption left.

Q22. Example: I set up a trust for my daughter, then it passes to my grandson after she dies. Is GSTT owed now?

Not at your gift. The GSTT applies later — when your daughter’s interest ends (a taxable termination).

Q23. Example: I leave $4.5M directly to my grandson at death. What happens?

If you haven’t used your $13.99 M GST exemption, you apply it. No GSTT due.

Q24. Example: A 95-year-old leaves property to her 30-year-old neighbor. Is that GSTT?

Yes. Since the neighbor is more than 37½ years younger, the IRS treats it like skipping two generations.

Q25. Do foreign heirs trigger GSTT?

Yes, GSTT applies regardless of whether the skip person is in the U.S. or abroad, if the transfer is subject to U.S. estate/gift tax.