Question:

My father-in-law set up an irrevocable trust which contains about $250,000 held in a non-IRA investment account. When he died in 2024, the funds were transferred to a bank account specified by the trust. Are any taxes due based on this initial transfer? I understand that taxes are due for income generated by the trust.

Response:

Whether there will be any tax due depends both on the holdings and the terms of the trust. If the trust were revocable, any investments in the trust would have received a step-up in basis and the only capital gain would be on any appreciation in the assets between the date of your father-in-law’s death and the sale of the assets.

This could also be true of an irrevocable trust. If your father-in-law retained certain powers over the trust, such as the right to income or the right to change the ultimate beneficiaries, then it would have remained in his taxable estate. Though his estate is much too small for there to be an estate tax, inclusion in his estate would also mean that the trust assets received a step-up in basis.

On the other hand, if your father-in-law retained no interest in the trust or power over it, then his creation and funding of the trust would have been treated for tax purposes as a completed gift at that time. In that case, the trust would not have been in his taxable estate and the assets would not have received a step-up in basis. If that were the case, the liquidation of the trust investments may have produced capital gain since such gain would have been calculated as the difference between what your father-in-law paid for the investments and what they were sold for upon liquidation. The trust would have to pay any tax on such gains.

In either case, whether the trust was or was not in your father-in-law’s taxable estate, the other income could include interest or dividends produced by the investments. Any tax due on such is likely to be very small. It would be paid by the trust if the resulting funds were retained in the trust and paid by the beneficiaries if it had been distributed to them.

 

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