The complexity of trust taxation arises because of several factors: When a trust earns income or pays expenses, the income or expenses are allocated either to principal or to income.In most cases, the trust document specifies which income or expenses are allocated to the principal or to income.If the trust accounting income consists of both tax-free and taxable income, then the tax-free and taxable portions of the income that is distributed must be allocated to each beneficiary.
However, expenses for the production of tax-free income are not deductible and depreciation can be claimed either by the trust or by the income beneficiaries or it can be apportioned to both according to the trust document.
Only a complex trust can deduct charitable contributions, but only if the trust document specifically allows it.
However, taxable income includes all income earned by the trust, including capital gains, minus tax-free income.
Typical trust expenses include trust administration expenses, expenses for the production of income, depreciation, and charitable contributions.
If money is distributed to the beneficiaries, then whether it is taxable or not to the beneficiaries will depend on whether principal or income was distributed, and if it was income, then whether it was tax-free income or retained income from previous years that the trust has already paid tax on.
Because trusts are not subject to double taxation, either principal or income on which the trust paid taxes can be distributed tax-free to the beneficiaries.
Charitable deductions are claimed on Form 1041-A, U. Information Return for Trust Accumulation of Charitable Amounts. Direct expenses for tax-free income are not deductible, since no taxes are paid on such income.
Indirect expenses, which are the expenses of administering the trust, are generally deductible, but if the trust has tax-free income, then a proportion, = tax-free income ÷ trust accounting income, of indirect expenses is not deductible.
Starting in 2018, under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, the tax brackets for 2018 and afterwards have changed slightly.