People often ask whether a trust should be part of an estate plan.  In this article, we will explain what a trust is and the difference between an Intervivos Trust and a Testamentary Trust.  



A trust is a document created for the purpose of holding and administering assets, such as selling assets, collecting income and distributing income or assets held by the trust to or for the benefit of the person or persons for whom the trust has been created (called a beneficiary).  The document creating the trust designates how the income and assets are to be distributed according to the wishes of the person creating the trust and will provide the powers granted to the person responsible for administering the trust.  A trust can be either an Intervivos Trust or a Testamentary Trust.  



An Intervivos Trust is a trust created by a person, called the grantor, during the grantor’s lifetime by which a person designated by the grantor, called the trustee, holds and administers assets for the benefit of the beneficiary.  The beneficiary is either the grantor or someone else designated by the grantor. 


An Intervivos Trust can be either revocable (meaning the grantor can change or terminate the trust at any time for any reason during the grantor’s lifetime) or irrevocable (meaning that once the trust is established, it generally cannot be changed or terminated except in very limited circumstances).  When a Revocable Intervivos Trust is established, the grantor is usually the trustee during the grantor’s lifetime, with one or more alternate trustees designated should the grantor die or become incompetent.  When an Irrevocable Intervivos Trust is established, the grantor is not the trustee but the grantor designates in the trust document who will be the trustee.


Two common forms of Intervivos Trusts are the Grantor Revocable Intervivos Trust and Totten Trust.  A Grantor Revocable Intervivos Trust is a trust where the grantor and beneficiary is the same person.  You can read more about this type of trust in the article Use of Trusts in Estate Planning-Why Create a Revocable Grantor Intervivos Trust?  A Totten Trust is a form of revocable trust created by a grantor with a bank account on which the grantor names a beneficiary.  The grantor is free to spend the money in the account at any time even to the point of exhausting the account.  However, if there are any funds left in the account upon the death of the grantor, those funds will pass to the named beneficiary.


It is very important that no matter how well intentioned the grantor and how well drafted an Intervivos Trust is, the trust is of no use unless the trust is funded.  What this means is that assets must be transferred to the trust and properly titled so that the trustee can administer the assets.  


How is Income an Intervivos Trust Receives Taxed?

The taxation of an Intervivos Trust depends on whether the trust is a revocable or irrevocable trust.  If the trust is a Revocable Grantor Intervivos Trust (where the grantor and beneficiary are the same person), the trust pays no income tax (and generally is not required to even file a tax return during the life of the grantor).  The grantor will report on the grantor’s individual income tax return all income received by the trust.  If the beneficiary is not the same person as the grantor, the Intervivos Trust may have to file a tax return and taxable income (such as bank interest and stock dividends) distributed to the beneficiary will be reported by the beneficiary on the beneficiary’s individual tax return and the distribution received may be taxable to the beneficiary.  



A Testamentary Trust is a trust included in a person’s Will.  The trust does not become effective until the person making the Will dies.  The Will includes the wishes of the person making the Will as to how the trust income and assets are to be distributed.  The Will also contains provisions designating the trustee (and any alternates) and the powers of the trustee.  Once a person dies, assets do not automatically go into the trust.  After the death of the person who made the Will, the estate must be administered.  As part of the administration of the estate, assets are transferred from the estate to the trust created under the Will.  The estate should not be closed until the assets designated in the Will to be left in trust have actually been transferred to the trust.  You can read more about this type of trust in the article Use of Trusts in Estate Planning-Why Create a Testamentary Trust?


How is Income a Testamentary Trust Receives Taxed?

A Testamentary Trust is a separate entity and is therefore taxed separately.  Whether any income is to be distributed to the beneficiaries of the trust will depend on the language of the trust.  To the extent income is distributed, the income received by the Testamentary Trust will be reported as income on its tax return but a deduction is generally available for the income (after expenses of the trust) distributed to the beneficiaries.  It is the beneficiaries who will then report the income received from the Testamentary Trust on the beneficiary’s individual income tax return.  If the Testamentary Trust accumulates income, the Testamentary Trust will pay tax on the net income (i.e. income after deductible expenses) it receives.


Other related articles that may be of interest are:


Use of Trusts in Estate Planning-Why Create A Revocable Grantor Intervivos Trust?

Use of Trusts in Estate Planning-Why Create a Testamentary Trust?

Use of Trusts in Estate Planning-Planning With a Subchapter S Corporation



IRS CIRCULAR 230 Disclosure:  To ensure compliance with requirements imposed by the IRS, please be aware that any U.S. federal tax advice contained in this communication (including any attachments or enclosures) is not intended or written to be used and cannot be used for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to any other person any transaction or matter addressed herein.

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Last Update: March 29, 2011