Who pays the taxes on income generated by trust-owned property depends on whether the trust is classified as a grantor or non-grantor trust. The vast majority of trusts are revocable grantor trusts for which the grantor pays the taxes using their individual income tax return to report the income and which use the grantor’s social security number as the tax identification number.
All revocable trusts are grantor trusts, trusts over which the grantor/creator of the trust retains the power to control or direct the trust’s income or assets. The grantor of a grantor trust pays the income tax for income generated by the trust. This type of trust income is generally reported on the individual’s income tax return, usually IRS Form 1040, using the grantor’s social security number.
Most irrevocable trusts are non-grantor trusts because the grantor has died or if alive has given assets and the right to income to the trust without retaining the type of personal control over the use of those assets and income that would cause the grantor to remain responsible for taxes due on the irrevocable trust’s income. This type of trust income is generally reported on a trust income tax return, usually IRS Form 1041 using the trust’s tax identification number, called an EIN or TIN.
Some irrevocable trusts are treated as grantor trusts, even though the grantor cannot change the terms of the trust. The grantor of these types of trusts has retained certain legally allowed powers over the trust income or property to cause the trust income to be attributable to the grantor of the trust even though the grantor doesn’t actually own the assets generating the income and cannot change the terms of the trust. We call these trusts intentionally defective grantor trusts.
One of the things they are good for is allowing a grantor with a taxable estate (currently over $13.99M) to make additional gifts in the form of payment of income taxes that will not be counted against that grantor’s lifetime gift exemption or estate tax exemption. In other words, it’s a way to reduce the value of a taxable estate’s ultimate estate tax exposure. If the grantor is also the trustee of the trust, then income from this this type of trust is generally reported on the grantor’s individual income tax return, usually IRS Form 1040. If the grantor is not the trustee of the trust, then income from this type of trust is usually reported on a trust income tax return, usually IRS Form 1041. A third authorized way to report income from this type of trust is through use of a complicated 1099 method which is rarely used.