A Non-Grantor Trust is a separate taxpaying entity for federal and state income tax purposes. A trust can be taxed for income tax purposes in two different ways: as a Grantor Trust (either taxed to the Grantor (as in an “IDGT”) or the Beneficiary (as in a “BDT”) or as a Non-Grantor Trust. As a Non-Grantor Trust, the trust will pay the income tax on the income that it earns, to the extent it retains the income. If the trustee distributes income to a beneficiary, the trust will receive an income tax deduction and the trustee will issue a 1099 to the beneficiary for the amount of income distributed. The beneficiary will report the 1099 trust income not he beneficiary’s personal federal and state income tax returns and will pay income tax at the beneficiary’s tax rate.
Because a Non-Grantor Trust is its own taxpayer for federal and state income tax purposes, it is important to try to structure a Non-Grantor Trust under the laws of a state like Nevada, which does not have a state income tax. Non-Grantor Trusts are used to reduce state income tax liability for residents of high-taxing states. Further, a Non-Grantor Trust may be used to shift income tax liability to beneficiaries who are in lower federal income tax brackets.
For more information on Non-Grantor Trusts, please contact us.