I am preparing some notes for a presentation I am making next week to some CFP students at UC Davis Extension. I have taught the whole 10 week class, in estate planning,  before.  This time I will be a guest lecturer in the tax class for CFP students. I will talking about the taxation of trusts and estates. One chapter I will be lecturing on is entitled “Simple v. Complex Trusts.”  Now most of my clients do not consider these issues at least not by these terms. However, your attorney may discuss it with you or, at least, they will think about it when they set up your trust… or at least they should. Let’s discuss….

When you write a trust there are two main ways to handle the distribution of income from the trust. This is typically an issue for after you die and how money should be distributed to your children or other loved ones. The distribution can say that “all income shall be distributed” at least annually or that “all income may be distributed” at least annually.  Wait a minute you say… what’s the difference!?  “May” v. “shall” is the difference.

Yes, it’s really that simple.  The issue of simple v. complex has nothing to do with how many pages your trust is, or how much legalese is used, but rather these simple little words.  In a simple trust all income SHALL be distributed at least annually. By distributing all income the trustee files a 1041 fiduciary income tax return and sends out a K-1. The K-1 will show all income being attributed to the underlying beneficiary and will be reported on their 1040. In a complex trust the trustee has the option to distribute the income and thus the income is taxed within the trust at the trust tax rates.  These rates are higher than the individual income tax rates.

If the income tax rates are higher why would anybody do a complex trust? There are many reasons but most notably it provides better asset protection. If the trustee is required to distribute the income there is no asset protection for those distributions and thus the trustee could be required to distribute them to your creditors.  On the other hand, if the trustee has the option of distributing the income that means she has the option to NOT distribute the money and thus opt to NOT pay a creditor that is hounding you. There may be other reasons but to me this is the most significant.

Yes, it’s that simple!

Send me an email or call me with any questions, be it simple or complex!

-John