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A trust tax is a tax assessed on income earned by a trust within a given year. Trusts are taxed just like individuals are and like individuals, a trust can also claim deductions to reduce tax liability. People should be aware that while trusts are sometimes utilized as abusive tax shelters, tax agencies are very aware of tax avoidance techniques and that if a trust is being established for tax purposes, people should be very careful about how it is handled to make sure that it falls within the law.
Funds put in a trust can earn interest in the form of income, returns on investments made with the funds, and so forth. Tax agencies usually have tax tables available which provide information about the tax rates for trusts. For example, the Internal Revenue Service (IRS) in the United States has divided trusts into a series of brackets on the basis of income. Each bracket has a base tax rate plus an additional tax rate in the form of a percentage of the income earned. The trust tax brackets are periodically adjusted in response to inflation and the base and percentage taxes fluctuate as well.
Tax returns must be filed for trusts as long as they are active. When a trust is dissolved, a final tax return must be filed documenting the fact that it was broken up and providing information about income earned up to the point at which it was dissolved. The tax return should disclose the amount of income and any eligible deductions being claimed and it is submitted with trust tax payments.
Trusts are entities, not human beings. This means that the deductions which can reduce tax liability are not the same as those which can be claimed by people. A trust tax can be reduced with deductions related to the expense of maintaining the trust, for example, but a trust cannot claim personal expenditures as deductions. People who receive payouts from a trust are also required to disclose this on their tax returns.
Trust tax issues can get extremely complicated. Working with an accountant or a lawyer who specializes in tax law is strongly recommended for people who administer or benefit from trusts to ensure that the trust is handled appropriately and that taxes are not over or underpaid. Genuine mistakes on tax returns do happen and are generally easy to fix, but if tax authorities believe that tax fraud is occurring, there can be severe penalties.