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Imagine a person who parents set up an irrevocable trust for him while he was alive. Upon the death of the parents, the parent's will setup another irrevocable trust. After the death of the parents the person will have two trusts.

When it comes time to filing income tax returns for the two trusts, will their be significate tax savings using two trusts because not all the income will be taxed at a high rate. Will there be additional complications because there are two trusts?

Note: All the profits from the trust may not be distributed every year. Hence the trust may end up paying a significant amount of income tax every year.

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    The incremental tax rate on a trust goes up pretty quickly - the IRS wants the trust income distributed. But there should not be 'complications' if the trusts are run as directed.
    – Jon Custer
    Apr 5, 2022 at 13:06

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The fact that these are two trusts and not one will provide some slight benefit because the retained profits are taxed at trust level and as such you'd be able to utilize the trust margins for each of them separately instead of combined.

However that benefit is not very large because trust marginal rates go up very quickly:

  • $0 to $2,650 10% of income over $0
  • $2,650 to $9,550 $265 + 24% of income over $2,650
  • $9,550 to $13,050 $1,921 + 35% of income over $9,550
  • $13,050 or more $3,146 + 37% of income over $13,050

Assuming both trusts have enough income to put them in the highest bracket, the benefit is that the first $13,050 of the second trust would be taxed at $3,146 instead of $4,828.50 they would have been had it been a single trust, giving you at most approximately $1,685.50 in tax savings.

So compared to individual tax brackets, trusts reach the maximum marginal rate at amounts where the individual may not pay any tax at all.

Generally, trusts are not tax efficient. To avoid unnecessary tax hit, all trust net income should be distributed to the beneficiaries and taxed on their individual tax returns.

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