The taxes applied to charitable trusts depend on both their investment incomes and the dates of their founding. If someone creates a revocable trust while still living, and it changes to an irrevocable structure after they die, said trust will not be deemed charitable until a settlement period has passed. The IRS applies the same rule to trusts that were created by wills to disburse assets to charitable beneficiaries.

Trust contributors may need to pay regular federal excise tax on money they want to add to their charitable trusts. They can still seek deductions, but these have to be approved by the IRS. Because the agency can treat trusts as private foundations starting from a range of dates, such as when the trusts were created or when their grantors died, tax obligations may vary based on other circumstances.

Trust structures serve as a common means of giving money to charity, but they are not immune from legal requirements. Arranging a trust in a certain fashion may have a huge impact on what percentage of the assets it contains actually makes its way to the intended recipient. Before creating a trust explicitly or through a will, grantors may wish to speak with an attorney.

Source: IRS.gov, “Charitable Trusts“, November 11, 2014

A fiduciary is responsible for making sound decisions in managing the assets and investments and avoiding taxes as much as possible. As a result, a financially inexperienced fiduciary is often advised to seek expert advice. Beneficiaries will want to know that fiduciaries are investing wisely, and a written investment plan can help reassure heirs about the fiduciary’s intentions.

Fiduciaries may make decisions about how income is distributed to beneficiaries. For example, a fiduciary may choose a combination of securities and cash. However, each trust is different, and fiduciaries must follow the rules of the trust.

Income tax is another responsibility of the fiduciary. In addition to providing a statement to beneficiaries who receive taxable income from the trust, a fiduciary is responsible for filing taxes on the trust. The fiduciary can be liable for any penalties as a result of late filing.

Because the job of trust administration can be complex, an individual who has been appointed as a fiduciary may want to consult an attorney. Even an individual who has acted as a fiduciary before may need guidance, as every trust is different. The individual may have previously administered a revocable trust and may now be faced with a special needs trust, an irrevocable trust or some other type. An attorney may also be helpful in setting up the right trust for individuals who are estate planning.

Source: American Bar Association, “Guidelines for Individual Executors & Trustees,” Accessed March 17, 2015

Once beneficiaries begin to receive disbursements from a trust, that money qualifies as taxable income. According to the website for the Internal Revenue Service, you as the trustee (the IRS refers to you as the “fiduciary”) have a role in the trust’s beneficiaries knowing how much tax they are expected to pay. Their tax liability is based upon the amount of income they received through the trust. Thus, you are required to figure out the trust’s accounting income in order to determine what the income distribution deduction will be. That deduction what is used to determine how much tax beneficiaries are required to pay as part of their annual return. You can to this by completing a Schedule B (IRS Form 1040).

Once this information has been determined, you will then complete an IRS Form 1041. This is the document that explains to the beneficiaries how much tax they must pay relative to their income distributions from the trust.

While these processes and forms may be new to you, an attorney may have extensive knowledge of this and any other tax obligations you have as trustee. Such a resource can help both you and the trust’s beneficiaries from experiencing any tax issues that could arise during the execution of the trust’s administration.

Trust companies are corporate entities that assume fiduciary responsibilities for both personal and business trusts. Often, their services are included in those offered by banks and other financial institutions, or they may simply be private firms whose sole function is trust management. Their staffs often consist of:

•          Attorneys
•          Financial planners
•          CPAs
•          Portfolio managers
•          Tax experts

Not only do trust companies specialize in the management of trust assets, they can assume the role of a personal representative of one’s estate. In such a capacity, they may handle the valuation and dispersal of estate assets, the settling of an estate’s debts and other liabilities, and the preparation and payment of taxes.

Given their obligations to both trust settlors and beneficiaries, trust companies are expected to support any and all actions taken with the respect to a trust’s assets and properties with adequate documentation. The Federal Deposit Insurance Corporation states in its Trust Examination Manual that such companies  should maintain current supporting documentation such as trust committee minutes, accounting statements and reviews, receipts for asset transfers, and written approvals for discretionary actions. Records for actions which assign indemnification to a trust company for losses should also be maintained.

Knowing the difference between principal vs income trust designations is key for trustees, especially when complying with California’s Probate Code and the terms of the trust. Accurate classification affects everything from distributions to beneficiaries to income taxes and long-term asset protection.

What Is Principal in a Trust?

Definition and Examples

As defined by the American Bar Association, what is principal trust property? It refers to the original trust assets placed into the trust to benefit beneficiaries. This may include:

• Money
• Real property
• Stock options

A trust’s principal can be gained or lost by the grantor adding to it or through any gains or losses made through the sale of trust property. Judgments awarded to the trust through a lawsuit are also considered to be additions to principal.

For taxable income and income tax purposes, principal is not considered ordinary income. Instead, it is a long-term holding that may influence estate taxes and must be reflected accurately in tax returns.

What Is Trust Income?

Understanding Income from Trust Assets

What is trust income in relation to principal? Income refers to any earnings generated by the trust’s principal. This may include:

• Interest earned from trust accounts
• Dividends from stock holdings
• Rental income from real estate in the trust

Income is any earnings generated by the principal, such as interest earned from trust accounts, dividends from stock holdings, or rental fees generated by trust properties. Asset allocations made from the trust will either come from its income or principal.

The difference between trust principal vs income determines how the income distributions are handled. Distributions to beneficiaries may be taxed as ordinary income, depending on the type of trust—such as a simple trust or a grantor trust.

Principal vs. Income in Trust Management

Why the Difference Matters

Understanding principal vs income is essential for trustees. Whether income is retained or distributed impacts the trust’s tax returns and the taxable income of beneficiaries. For income tax purposes, income is usually taxed at the individual beneficiary’s rate, while principal may be shielded for asset protection or estate planning purposes.

Investment managers must also understand this distinction, as it influences how assets managed by the trust are allocated. A trustee’s failure to properly distinguish between the two can lead to disputes or legal issues.

California Probate Code Guidelines

According to the California Probate Code, receipts and/or disbursements from a trust’s principal and income are to be determined by the trustee in a clearly defined order. First, he or she is expected to make trust allocations in accordance with the trust instrument or will that created it. If no such provisions are included but such documents do empower him or her to use his or her own discretion, then he or she may do so. If no such language is present in any estate documents, the trustee is expected to allocate a trust’s principal and income according to the Probate Code.

What Is a Qualified Income Trust?

A qualified income trust (QIT), also known as a Miller Trust, is a specific type of trust often used in Medicaid planning. It allows individuals with income above Medicaid eligibility limits to qualify by diverting excess income into a trust.

While not used in California, QITs are important for families in states where Medicaid rules are stricter. In all cases, understanding principal vs income remains critical to ensure proper compliance and accurate distributions to beneficiaries.

Need help understanding trust administration, principal and income rules, or how your trust affects income taxes and estate taxes? At the Law Offices of Alice A. Salvo, we can guide you through every aspect of your estate plan, trust creation, or trust management. Contact our team today for trusted legal support in Woodland Hills and throughout Los Angeles.

In simpler terms, with a split-interest trust, one can pass a portion of his or her wealth to a beneficiary while also contributing to a charitable organization. Such trusts are set up using one of two different payment methods. The first is a charitable lead trust, which pays income to a charity for certain period of time, and then sees the remainder interest pass to its beneficiaries. A charitable remainder trust, on the other hand, follows the exact opposite payment method.

According to the California Probate Code, trustees of split-interest trusts are prohibited from engaging in any of the following activities as they are defined by the Internal Revenue Code:

•          Engaging in self-dealing
•          Retaining excessive business holdings
•          Making investments that would makes trust property subject to tax+
•          Making taxable expenditures

In terms of taxes, the beneficiaries are able to bypass the federal estate tax when they inherit assets from charitable lead trust. The trust donor, however, may have to pay tax on contributions meant specifically for beneficiaries. With a charitable remainder trust, beneficiaries do have to pay tax on their income dispersals.

The Legal Information Institute of the Cornell University Law School defines a breach of trust as being any trustee action that violate the terms of a trust. It goes on to say that such actions do not always have to be intentional; one’s negligence or carelessness may also constitute a violation of his or her duties.

One may read that and automatically assume any failings on the part of a trustee should result in a liability claim. However, the California Probate Code does allow trustees relief from liability when it is offered by the settlor in the trust instrument. For example, if a settlor encourages a trustee to be aggressive in pursuing investments in order to generate income, and states that he or she will not be held liable if such investments net losses, then the trustee may not be deemed responsible for such losses.

The law goes on to say, however, that such relief does not apply in the following cases:

•          If a breach of trust was committed intentionally.
•          If the trustee operated in bad faith, or with gross negligence or reckless indifference to the interests of beneficiaries.
•          If the trustee profited from the breach of trust.

It also states that to avoid liability in cases where beneficiaries fail to object to a trustee’s actions, the trustee must offer adequate notice to allow for objections to be made.

According to Section 18000 of the California Probate Code, you are generally viewed as not being personally liable for any contracts you may enter into while fulfilling a trustee’s designated fiduciary duties. The same holds true disputes arising from ownership or control of trust property, and even tortious actions committed while administering a trust.

The freedom from liability described above should not prompt you to believe that you can do anything you want as a trustee, however. Any actions in which you are personally at fault could result in your being held liable. Regarding contractual relationships, you could also be deemed liable if you do not state your role as a trustee in a contract.

What if you are a co-trustee, and one or all of your partners is found personally liable for errors in your collective trust administration efforts? If you dissented to the action that resulted in the liability claim, and shared your dissent with your co-trustees in writing prior to the action being taken, you may escape from being considered to be jointly responsible.

More information on your legal rights as a trustee can found by exploring our site further.

Such is the claim being made by a Florida woman seeking to wrest control of the trusts set up by her late estranged husband from the bank currently serving as trustee. While the trust provides her with an annual $800,000 income, outsiders may view her as essentially being disinherited along with her daughter and the decedent’s other children (all of whom with which he had no relationship towards the end of his life).

The man did end up leaving left $2.3 million to his ranch manager, farm hand and caretaker, along with assets totaling $1.3 million to his longtime friend. In contrast, he left each of his daughters $1 million, and only $100,000 to his stepdaughter. His estranged wife is set to continue to receive income from the trust up until her death, at which time the entirety of the estate’s assets would pass to a community trust to support various charities. She is now arguing that the bank managing his trust should be stripped of its role as trustee, alleging that its managers persuaded the decedent to take control of the trust away from her.

Those looking to either validate or invalidate one’s final wishes may wish to secure the services of an attorney to assist in doing so.

Source: Orlando Sentinel “Battle over $43 million estate explodes in vitriol” Ritchie, Lauren, July 28, 2017

The first thing to know is that every California trust is unique and they often vary in terms of their size and complexity. However, it’s important to recognize that most trust administrations are complicated. Therefore, it’s in the best interest to work with an experienced California trust attorney during a trust administration. The experienced California trust attorneys of the Law Offices of Alice  A. Salvo have the experience you need to navigate the trust administration process. Please get in touch with us online or by phone to schedule an appointment today.

What is a California Trust?

A California trust is a device used by a trust creator (grantor or settlor) for the benefit of named beneficiaries. The grantor transfers ownership of assets into a trust that a designated trustee oversees. The trustee is responsible for managing the trust, making disbursements to beneficiaries, and ensuring that the trust terms are carried out.

What is a California Trust Administration?

A California trust administration is the process that the trustee will follow to attend to the trust after the grantor passes away. Trust administration involves completing several tasks, and it’s important to have the advice of an experienced California trust attorney at every stage.

What Happens During a California Trust Administration?

When the trust grantor passes away, the trustee will have several responsibilities including:

• Providing notice to the right parties and authorities
• Organizing and gathering important documents
• Assessing and accounting for trust assets
• Managing federal tax responsibilities
• Protecting trust assets and paying applicable debts
• Distributing trust assets to the beneficiaries

Notify the beneficiaries of the trust administration: When the trust administration begins, the trustee is required by California law to notify the trust beneficiaries and the grantor’s heirs. The purpose of the notification is to let these individuals know the status and provide them with an opportunity to contest the trust.

Written notices must be sent out to beneficiaries of the trust and the grantor’s heirs within a certain number of days from the grantor’s death. The grantor’s heirs and trust beneficiaries will have a set period from the receiving date to contest the trust.

Organize and gather important documents: These typically include a copy of the death certificate, the trust document, and other essential estate planning documents. The trustee will need to organize and gather these and all other necessary documents.

Asset Accounting: The trust assets will remain in the trust when the grantor dies. The trustee will be responsible for protecting this property and ensuring it remains as the grantor devised. During the trust administration, the trustee should conduct an accounting of the assets and trust income. This will include identifying the existing trust property and having it valued. In addition, the trustee must accurately report any income earned by the trust to the IRS.

Medi-Cal Notification: If the decedent was a Medi-Cal (California Medicaid) recipient, the grantor’s executor or the trustee will have a specific number of days from the date of death to file a notice of the grantor’s death with Medi-Cal.

Real Property Notice: The trustee will have a certain number of days after the death to file a Notice of Death of Real Property to effectuate a change in ownership. This notice will be filed with the death certificate. This part of the trust administration process can be complicated, and trustees usually need the help of an attorney.

Debts and Liabilities

The trustee must also settle the grantor’s debts and liabilities during a California trust administration. This will involve tracking and recording trust deposits and distributions.

Asset Distribution

Once all of the required trust administration tasks are completed, the trustee can distribute the trust assets according to the trust terms.

These are just some of the requirements for a California trust administration. Depending on the trust, the trustee may have other tasks to complete. If you are a trustee, trust administrator, beneficiary, or heir to a California trust, you should consult with an experienced California trust attorney. Your trust lawyer can help you protect your interests and ensure that the trust is properly administered.

At the Law Offices of Alice A. Salvo, we are experienced California trust attorneys who understand how trust administration works and can help. Please call us today at 818-676-9572 to schedule your free consultation.