Trusts are often described as a way to avoid probate, and many do that well. Fewer people realize that each kind of trust is taxed differently. Picking the right one can affect income tax every year and, for larger estates, estate tax at death.
Revocable living trusts
A revocable trust is the kind most families use. You keep control, you can change it, and you usually serve as your own trustee. For income tax, the IRS treats it as if it doesn’t exist. You report the trust’s income on your own return, just as before. It also stays part of your estate for estate tax purposes. Its value lies in managing property if you become incapacitated and passing it on without probate.
Irrevocable grantor trusts
Some irrevocable trusts are written so the person who created them still pays the income tax on trust earnings. That sounds like a downside, but it can help. The trust assets grow without being reduced by tax, and the creator’s tax payments move more value to the family without counting as extra gifts. Families with larger estates often use this approach.
Non-grantor trusts
A non-grantor trust is its own taxpayer with its own return. The problem is the rate schedule. A trust reaches the top 37% federal rate after roughly $16,000 of retained income, while an individual doesn’t reach that rate until well over $600,000. When a trust distributes income to beneficiaries, the tax generally shifts to them at their own rates. How and when a trustee distributes income can make a real difference.
Estate and gift tax
In 2026 the federal estate and gift tax exemption is $15 million per person, and it will rise with inflation in later years. Married couples can shelter about $30 million together. You can also give up to $19,000 per recipient in 2026 without using any of your exemption. Most families will never owe federal estate tax, but the exemption level shapes which trusts are worth the cost and complexity.
Basis at death
Property that passes at death usually gets a new tax basis equal to its value on the date of death. Heirs who sell soon after often owe little or no capital gains tax. Property given away during life keeps the giver’s original basis. For assets that have gained a lot of value, such as land or a family business, the choice between giving now and leaving it at death can matter more than the estate tax.
Putting it together
The right trust depends on your goals, your assets and who you want to protect. Attorney Fenelus holds an LL.M. in Taxation and builds estate plans with the tax side in mind. Our estate planning services are offered in North Dakota, including remote consultations. Call us at 703-649-4848.
This article is educational and general in nature. It is not individualized legal or tax advice, and reading it does not create an attorney-client relationship. Tax law changes often, so talk with a qualified professional about your own situation.
