Liquidating trust and tax
Beneficiaries of a trust typically pay taxes on the distributions they receive from the trust's income, rather than the trust itself paying the tax.
However, such beneficiaries are not subject to taxes on distributions from the trust's principal.
At the same time, the trust issues a K-1, which breaks down the distribution, or how much of the distributed money came from principal versus interest.
The K-1 is the form that lets the beneficiary know his tax liability from trust distributions.
This is usually the original contribution plus subsequent ones and is income in excess of the amount distributed.
Capital gains from this amount may be taxable to either the trust or the beneficiary.
Instead, gain or loss is delayed until you sell the property.
If the income or deduction is part of a change in the principal or part of the estate's distributable income, income tax is paid by the trust and not passed on to the beneficiary.
The K-1 schedule for taxing distributed amounts is generated by the trust and handed over to the IRS.
The IRS, in turn, delivers the document to the beneficiary to pay the tax.
When a trust makes a distribution, it deducts the income distributed on its own tax return and issues the beneficiary a tax form called a K-1.
The K-1 indicates how much of the beneficiary's distribution is interest income versus principal and, thus, how much the beneficiary is required to claim as taxable income when filing taxes.