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What is a Complex Trust?

Estate Planners | Monday, August 1st, 2011

All trusts must be classified in one of two ways for the purpose of paying federal income taxes – as a simple trust or a complex trust.  Basically, a complex trust is one that cannot be classified as simple.   In a nutshell, the complex trust is one that contains provisions for charitable gifts, an income stream, or concerns other types of wealth distribution.  A simple trust that fails to distribute current income can be treated as a complex trust for tax purposes, and trusts can flip-flop back and forth between the two classifications if the trustee does not handle the income in an appropriate manner.  (This can get complicated and expensive, as the simple trust is afforded a higher standard deduction than its complex counterpart).

During the tax year, the complex trust must satisfy at least one of these conditions in order to be considered “complex”:

* Retain some current income within the trust.

* Provide for amounts to be paid that are permanently set aside from other monies or assets within the trust, to be used for charitable gifts.

* Distribute amounted allocated to the principal of the trust.

Much like the simple trust format, the complex trust can take a deduction for income that is distributed to beneficiaries. And like an estate, the complex trust may deduct an unlimited amount of income that is paid to a recognized charity or non-profit organization as well as other monies that were appropriately required, credited, or paid to beneficiaries. In turn, when a beneficiary receives income from a complex trust, just like in a simple trust, the income that they receive must be reported as income when they file taxes for the calendar year that the income was received.

In a nutshell the differences between a simple trust and a complex trust are clear. The simple trust must pay its current income to the beneficiaries that are listed in the trust instrument. A complex trust does not.

In a complex trust, trust income and expenses for the trust are separated by principal and income. The income part of the trust can be distributed to the beneficiaries, and the principal will stay within the trust until the trust expires, regardless of whether there are losses to the amount of principal within the trust. At that time, the expenses can be allocated to both principal and income. This allocation is determined by state law. Expenses for the trust include any item that is relevant and allowable for managing the trust, including financial management fees, state taxes and so on. The ordinary income from the trust can be from various sources, including interest, dividends, rental income, royalties, and so on, and this income can be distributed to the beneficiaries or stay inside the trust and the trust will pay taxes on the income. The capital gains and losses will stay inside the trust until its expiration. The trust instrument will determine whether tax on distributions are payable by the trust or by the individual beneficiary.

To find out more about complex trusts, consult with an estate planner who can review your situation and determine the best type of trust for you and your family.

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