10 IRS Topics Regarding Trusts
The topics here are part of an extensive IRS document titled Trusts: Common Law and IRC 501(c)(3) and 4947i. The document is in response to questions received, and it discusses common-law and federal tax definitions, and rules regarding trusts.
- What is a trust? – The definition presented by the IRS states that a trust is “a fiduciary relationship with respect to property, subjecting the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.” and “Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.”
- Who are the parties to a trust? – These are the entities (parties) and relationships involved in a trust:
- A trust cannot exist without assets. – As the definition of a trust is about a relationship by which one party is trusted with the management, conservation, and protection of “property” on behalf of another, there must be assets involved.
- A trust cannot exist without a trustee. – If a trustee dies, becomes incapacitated or unable to perform their duties, or is removed by a court, there will be another trustee appointed by the court.
- How many trustees are required for a trust? – A single trustee is all that is required in most cases under current law, though some charitable and other trusts may be set up with a governing board.
- Must a trust register with the State? – Unlike corporations or other business structures, there is no state filing requirement for trusts. An exception is when a trust is included in a will. This will be part of the probate process as regulated by state law.
- When are courts involved in the regulation of trusts? – There are several ways in which the courts can be involved in the management and regulation of trusts:
- Changing the terms of a trusts or reformation of a trust.
- At times, the trustee(s) may be required to account to a court for their administration activities.
- Beneficiaries may sue for an accounting or for trust terms changes or violations.
- Trustees may ask a court for instructions in the performance of their duties.
- A trust may exist without a written document, but – Without a written document, a trust cannot pass the organizational test in 501(c)(3).
- Can a trust carry on a business? – The short answer is yes legally, even under 501(c)(3). However, due to liability concerns, it is usually better to conduct business in a corporate structure.
- Are there special tax considerations or rules for trusts? – There are instances in the area of Exempt Organizations for taxes where a trust must follow special rules.
- Nonexempt charitable trusts and split-interest trusts have special rules for tax purposes.
- Some IRC exemptions are not available to trusts.
- A trust is classified as a business entity for taxes if it conducts business for the profit of its owners. This does not include the holding of stocks and bonds or the passive rental of real estate.
There are 17 other topics in this document for those who want to do a deep dive into trusts and their tax treatment.