Taxes & Trusts: How They’re Taxed, What to Watch, And How to Plan

Acronyms You'll Read About

• RLT — Revocable Living Trust (probate-avoidance hub; grantor-taxed while you’re alive)

• DNI — Distributable Net Income (limits what a trust can “carry out” to beneficiaries for income-tax purposes)

• NIIT — 3.8% Net Investment Income Tax (applies above low trust thresholds)

• QSST / ESBT — S-Corp trust elections: Qualified Subchapter S Trust / Electing Small Business Trust

• ILIT — Irrevocable Life Insurance Trust (usually grantor-taxed; estate-tax exclusion for proceeds if structured correctly)

• CRT / CLT — Charitable Remainder/Lead Trusts (split-interest trusts with special tax rules)

• SRT — Stand-Alone Retirement Trust (for inherited IRAs/401(k)s; SECURE-aware)

• EDB — Eligible Designated Beneficiary under the SECURE Act (certain people who can stretch)

• DSUE — Deceased Spousal Unused Exclusion (estate-tax portability via IRS Form 706)

The First Fork in the Road:

Grantor vs. Non-Grantor

Grantor Trust (most common for lifetime planning):
Income is reported on the grantor’s 1040. This is by design: it lets the trust grow income-tax free (to the trust) while you, the grantor, quietly pay the tax—an additional, tax-efficient gift without using annual exclusion. Tools: RLTs, many ILITs, IDGTs, SLATs with “intentionally defective” features, and swap powers (to manage basis).

Non-Grantor Trust:
The trust is its own taxpayer. Trust brackets are compressed—the top federal rate and NIIT kick in at very low income. The lever here is DNI: distribute taxable income to push tax to a beneficiary in a lower bracket, or accumulate if protection goals trump taxes. Use non-grantor status when you want state-tax arbitrage, cap SALT exposure, or deliberately wall off income.

Planning note: You can often toggle grantor status with carefully chosen powers (IRC §§671–679). We draft for flexibility, with a trust protector to add/remove powers if tax posture changes.

RLTs, Basis, and the “Step-Up”

An RLT is ignored for income tax during life (grantor-taxed). On death, RLT assets are included in your estate and generally receive a basis step-up. If you used an irrevocable non-grantor trust that keeps assets out of your estate, you may forgo step-up. We often keep swap powers (grantor power under §675(4)(C)) so you can swap low-basis assets back into your estate near end-of-life and gift out high-basis assets—maximizing step-up without changing beneficial interests.

Retirement Accounts & Trusts: SECURE Act Reality

• Conduit trust: Passes out every IRA/401(k) distribution to the beneficiary. Simple, but zero protection and can force a big tax hit by year 10.

• Accumulation trust (our default SRT): The trustee captures IRA payouts and can drip or hold them—protecting from divorce/creditors and coordinating brackets. Trade-off: any undistributed IRA dollars taxed at trust rates.

EDBs (spouse, minor child of decedent until majority, disabled/chronically ill beneficiaries, and beneficiaries not more than 10 years younger) have special stretch options; otherwise, the 10-year rule applies. We draft SRTs with SECURE-aware definitions, separate-share preservation, and charity overlays (e.g., CRT design) when a “lifetime-like” stream is essential.

IRD Warning: Retirement dollars are income in respect of a decedent—no basis step-up. Trust design is your main lever.

S-Corp Shares in Trust

QSST vs. ESBT

• QSST: All S income taxed to one individual beneficiary; strict distribution rules but simple taxation.

• ESBT: The S-portion is taxed at the highest individual rate (flat), regardless of distributions; non-S portions use normal trust rules. ESBT is flexible for multiple beneficiaries and often the safer default for complex families.

We add QSST/ESBT election language and calendar the elections; missing them can blow S-status.

Charitable Trusts & DAFs

Taxes With Purpose

CRT (Charitable Remainder Trust): You gift appreciated assets; the CRT sells tax-deferred, pays you (or others) an annuity or unitrust amount, and leaves the remainder to charity. You may get an income-tax deduction up front; income you receive is taxed under a tier system. Excellent for low-basis stock or real estate where you want income + deferral + charity.

CLT (Charitable Lead Trust): Charity gets the lead payments, your family gets the remainder. Powerful for estate/GST reduction in low-rate environments or when assets are poised to appreciate.

DAF (Donor-Advised Fund): One-receipt giving, bunch deductions, and name successor advisors (kids) to continue family philanthropy.

ILITs: Estate-Tax-Free Liquidity

ILIT-owned life insurance keeps proceeds out of your estate (if structured correctly), creates creditor-resistant cash to pay taxes, equalize shares, or keep the shore house. Many ILITs are grantor trusts (income taxed to you—typically minimal). Watch the 3-year rule if assigning an existing policy; manage Crummey notices and Form 709 filings. We run the administration under AMP/CCP so audits are boring.

When To Accumulate vs. Distribute

A Simple Framework

• Distribute when beneficiaries are in lower brackets, below NIIT, and you’re not sacrificing protection. Use the 65-day election to tune.

• Accumulate when asset protection, divorce risk, special-needs concerns, or spend-thrift behavior outweigh tax savings. Consider sprinkling to multiple beneficiaries to optimize brackets while preserving guardrails.

We write HEMS standards, incentives, co-trustee step-ups by age, and limited powers of appointment to keep the plan humane and flexible.

Tips, Tricks, and Traps

Lawful Mitigation 

• Use grantor trusts so you pay the tax and the trust compounds.

• Leverage DNI + 65-day rule to push income to lower-bracket beneficiaries when safe.

• Control capital gains with drafting that allows gains to be carried out when desired.

• Mind NIIT thresholds; pair distributions with charitable gifts (DAF) or Roth conversions.

• Coordinate NJ residency (trustees, assets, sourcing) to reduce state tax drag.

• Choose QSST/ESBT wisely for S-corp holdings.

• SECURE-aware SRTs for inherited retirement dollars; consider CRTs when a true “stretch-like” income is the goal.

• Preserve step-up via estate inclusion or swap powers for the lowest-basis assets.

Common Tax Traps We Prevent

• Old conduit IRA provisions that force out protected funds under the 10-year rule.

• Capital gains trapped at the trust level without any ability to carry out.

• Missed QSST/ESBT elections → S-status risk.

• Assigning a policy to an ILIT and dying within 3 years (estate inclusion).

• NJ “resident trust” with a NJ trustee and NJ assets—accidentally taxable when it didn’t need to be.

• No 706 at first death → lost portability (DSUE).

• No Crummey notices → gifts lose annual-exclusion treatment.

NJ-Specific Callouts

• Estate Tax: NJ estate tax is currently repealed, but inheritance tax still applies for non-Class-A beneficiaries (siblings, nieces/nephews, friends). We time and route gifts accordingly.

• Real Property: NJ-source income is taxed in NJ even if the trust is non-resident. Rentals require special handling.

• Probate: A funded RLT avoids public probate and its 3–7% friction so taxes aren’t paid with delay penalties and fire-sale discounts.

How We Work

Design → Draft → Fund → Maintain

1. Tax-First Design: Grantor vs. non-grantor posture, DNI strategy, NIIT mapping, QSST/ESBT readiness, SECURE-aware SRTs, CRT/CLT/DAF fit, NJ residency plan.

2. Draft & Coordinate: RLT, advanced trusts (IDGT/SLAT/ILIT/SRT/SNT/CRT/CLT), marital layer (CST/QTIP + Clayton + 706).

3. Funding: Deeds, titles, beneficiary forms (retirement/insurance/annuity), entity interests; S-corp elections; ILIT Crummey calendars.

4. Maintenance: AMP (annual tax & funding scorecard) or CCP (quarterly Advisor Summits with CPA/EA and CFP®/RIA; elections, notices, and 65-day planning).

Quick FAQs

Do trusts pay more tax than people?
Often, yes—non-grantor trusts hit top brackets and NIIT at low income. That’s why DNI and the 65-day election matter.

Can we get a step-up on assets in an irrevocable trust?
Only if they’re estate-included. We often keep swap powers so low-basis assets can be pulled back for step-up.

Should my IRA name my RLT?
Usually no. We prefer an SRT tailored for SECURE Act rules and protection; we align beneficiary forms to it.

Which is better for S-corp stock—QSST or ESBT?
Depends: QSST is simpler for one beneficiary; ESBT is flexible for multiple beneficiaries but taxes S income at the top rate. We choose intentionally.

Are CRTs “tax shelters”?
They’re tax-favored, not abusive: you get a deduction, defer gains inside the CRT, and receive a taxable payout by tiering. Great for low-basis assets + charitable intent.