How to Pay a Trust’s Expenses
In addition to making payments to the beneficiaries, as trustee, you’re also responsible for paying the expenses you incur in administering the trust. The primary expenses include trustee’s fees, investment advice, accounting fees, and taxes.
A trustee’s fee is the amount the trust pays to compensate the trustee for his or her time. There is no set trustee’s fee. You can choose to base it on a small percentage of the market value of the assets plus a percentage of the income earned by the trust. You may opt to calculate the number of hours you spend and bill by the hour. You may even charge a flat fee, which is more like an honorarium. What you may not do is overcharge.
Trustee fees are an income tax deduction for the trust but taxable income to you. You must declare these fees on your Form 1040, where you place them on line 21, Other Income. If you’re a professional trustee, this income is also subject to Self-Employment Tax. Otherwise, it’s income taxable only.
Trustee fees are typically paid both from principal and income so as not to burden either side unduly.
Investment advice in a trust
Investment advice is deductible to the trust minus the 2 percent haircut to which miscellaneous itemized deductions are subject.
Trust’s accounting fees
Unless you’re preparing Form 1041 by yourself, you also have to pay accounting or tax preparation fees. You may choose to pay these from income or principal, or a combination of the two. Accounting fees in a trust are usually charged on an hourly basis or on the complexity of the returns being prepared, and are fully deductible.
Taxes in a trust
State and local income taxes, real estate taxes, and personal property taxes are all deductible if paid by the trust on trust obligations. So, if the trust owns real estate, it gets to deduct those taxes. If, on the other hand, the trust pays the real estate taxes on property owned by the income beneficiary, the trust has actually made a distribution to the beneficiary.
If the trust is only paying a capital gains tax, you pay that from principal.
If the trust is accumulating income, you pay the entire tax from principal because the accumulated income is transferred to principal at the end of each year and becomes part of the principal.
On occasion, when you don’t transfer accumulated income to principal, you pay taxes on the ordinary income of the trust from the income side, and the capital gains taxes from the principal side.
To the extent that income is available in the trust to pass out to a beneficiary, that tax payment becomes an income distribution, and the beneficiary will receive a Schedule K-1 from the trust.
Unlike individuals, who may deduct state sales taxes rather than state income taxes, state sales tax deductions aren’t available for trusts. After all, trusts don’t buy anything except for services, and those services typically aren’t subject to sales tax.