Question:

I am the trustee of my parents’ trust. They have now both passed away. I want to liquidate and distribute the proceeds to the beneficiaries. Does the trust have to pay taxes upon liquidation, even if it is for the purpose of distribution?

Response:

Probably not (though I couldn’t be absolutely certain without seeing the trust).

There are two possible types of taxes: one on capital gains when you liquidate the trust property in order to distribute cash to the beneficiaries; the other on any income the trust may have earned from dividends or interest.

In all likelihood, there will be little or no capital gain because the assets held by the trust received a so-called “step-up” in basis when the second of your parents passed away. This means that the tax basis for determining any capital gain on the sale of trust property will be its value on the date of death. As a result, the only capital gain that you would incur on liquidating the property for distribution would be the increase in the value of the trust property since then. Assuming that was recent, such increase should be small. Even if the trust did incur a small capital gain on the sale of the property, it would not in fact pay the tax. Instead, it would pass such gain through to the beneficiaries who would then pay the tax due, if any.

That’s also true of any dividends or interest the trust property may have earned since your parent’s death. You will report it on the 1041 tax return for the trust, on which you will also be able to deduct trust expenses, such as legal and accounting fees. Any net income earned in excess of the deductions will pass through to the beneficiaries. You will give them notice of the pass-through capital gains and income, if any, by issuing them a K-1 tax form.

 

Related Articles:

What’s a “Step-Up” in Basis and Why Would You Want It?

Will Distributions from Our Parents’ Trust be Taxed?

How Are Revocable and Irrevocable Trusts Taxed?

What is the Tax Treatment of Trustee Fees?