Living Trust Tax Benefits California 2025: What You Need to Know

Do Living Trusts Reduce Taxes? (The Honest Answer)

Let's start with the truth many trust promoters won't tell you:

So why do people create living trusts? To avoid probate, not taxes.

What Living Trusts Actually Save

A revocable living trust saves you money by avoiding California probate:

• Probate attorney fees: 4% on first $100K, 3% on next $100K, 2% on next $800K (statutory fees)
• Executor fees: Same percentage as attorney fees
• Court costs: $435+ in filing fees
• Time cost: 12-18 months tied up in probate court vs 2-4 weeks with a trust

Example probate costs for $600,000 estate:

• Attorney fees: $17,000
• Executor fees: $17,000
• Court costs: $435
• Total: $34,435 + 12-18 months

With a living trust: $0 in probate costs + 2-4 weeks to distribute assets.

Federal Estate Tax: $13.99 Million Exemption (2025)

The federal estate tax is often called the "death tax." It's a tax on the transfer of your estate after death.

2025 Federal Estate Tax Exemption

• Individual exemption: $13.99 million
• Married couple exemption: $27.98 million (with portability)
• Tax rate: 40% on amounts over exemption
• Applies to: Only 0.1% of estates (ultra-wealthy)

What This Means for You

If your estate is under $13.99 million: You pay ZERO federal estate tax regardless of whether you have a trust, a will, or nothing.

If your estate exceeds $13.99 million: You owe 40% tax on the excess. A revocable living trust does NOT help. You need irrevocable trusts for estate tax planning.

Estate Tax Calculation Examples

Estate Value	Exemption Amount	Taxable Amount	Estate Tax (40%)
$1 million	$13.99 million	$0	$0
$5 million	$13.99 million	$0	$0
$10 million	$13.99 million	$0	$0
$13.99 million	$13.99 million	$0	$0
$20 million	$13.99 million	$6.01 million	$2.4 million
$30 million	$13.99 million	$16.01 million	$6.4 million

Portability for Married Couples

Married couples can effectively double the exemption to $27.98 million through "portability."

How portability works:

1. When first spouse dies with $10M estate (under $13.99M exemption), no estate tax
2. Surviving spouse can claim the unused exemption ($3.99M unused)
3. Surviving spouse now has $13.99M + $3.99M = $17.98M exemption
4. Must file IRS Form 706 within 9 months of first spouse's death to claim portability

Important: Portability only works for federal estate tax. Some states don't allow portability (but California has no state estate tax anyway).

California Has No State Estate Tax (Good News!)

Here's some excellent news for California residents:

States With Estate or Inheritance Taxes (2025)

California residents are lucky. These 12 states still have estate or inheritance taxes:

Estate Tax States:

• Connecticut (exemption: $13.99M, matches federal)
• Hawaii (exemption: $5.49M)
• Illinois (exemption: $4M)
• Maine (exemption: $6.8M)
• Massachusetts (exemption: $2M - lowest!)
• Minnesota (exemption: $3M)
• New York (exemption: $6.94M)
• Oregon (exemption: $1M - second lowest!)
• Rhode Island (exemption: $1.7M)
• Vermont (exemption: $5M)
• Washington (exemption: $2.2M)
• District of Columbia (exemption: $4.5M)

Inheritance Tax States:

• Iowa (0-15% tax, being phased out)
• Kentucky (0-16% tax)
• Maryland (0-10% tax, also has estate tax)
• Nebraska (1-18% tax)
• New Jersey (0-16% tax)
• Pennsylvania (0-15% tax)

If you're moving from these states to California: You'll save on estate/inheritance taxes automatically.

Income Tax Treatment: No Difference from Owning Personally

Here's the critical fact about living trust income taxes:

How Revocable Living Trust Taxes Work

Income from trust assets:

• Rental income from trust property → Your Form 1040
• Interest from trust bank accounts → Your Form 1040
• Dividends from trust investments → Your Form 1040
• Capital gains from trust sales → Your Form 1040

Tax forms you receive:

• 1099-INT (interest) issued to: You or Your Trust (doesn't matter)
• 1099-DIV (dividends) issued to: You or Your Trust (doesn't matter)
• 1099-B (capital gains) issued to: You or Your Trust (doesn't matter)

You report everything on your personal return just as you did before creating the trust.

Why Revocable Trusts Don't File Separate Returns

IRS rules classify revocable living trusts as "grantor trusts." This means:

• Grantor (you) is treated as owner for tax purposes
• All income taxed to you, not the trust
• Trust doesn't file Form 1041 (trust tax return)
• You use your Social Security Number (SSN), not a separate EIN

Example: $100,000 Trust Income

Scenario: Your revocable living trust owns a rental property generating $30,000 annual net income, plus investments generating $70,000 in dividends.

Without trust:

• Report $30,000 rental income on Schedule E
• Report $70,000 dividends on Schedule B
• Total income: $100,000 on Form 1040
• Pay income tax based on your tax bracket

With revocable living trust:

• Report $30,000 rental income on Schedule E
• Report $70,000 dividends on Schedule B
• Total income: $100,000 on Form 1040
• Pay income tax based on your tax bracket

Result: Exactly the same. Zero tax difference.

Capital Gains Tax & Step-Up in Basis Explained

One of the most valuable tax benefits in estate planning is the "step-up in basis" at death. But does a living trust affect this?

What is Step-Up in Basis?

Step-up in basis is a tax rule that resets the cost basis of inherited assets to their fair market value on the date of death, eliminating capital gains taxes on appreciation during the deceased's lifetime.

Example without step-up:

• You bought stock in 1990 for $50,000 (your "basis")
• Stock worth $500,000 when you die in 2025
• Without step-up: Heirs who sell owe capital gains tax on $450,000 gain (20% federal + 13.3% California = $149,850 tax)

Example with step-up:

• You bought stock in 1990 for $50,000
• Stock worth $500,000 when you die in 2025
• With step-up: Basis reset to $500,000 on date of death
• Heirs inherit at $500,000 basis
• If heirs sell immediately for $500,000: $0 capital gains tax

Tax savings from step-up in basis: $149,850

Does a Living Trust Affect Step-Up in Basis?

Step-Up in Basis for California Married Couples

California is a community property state, which provides a special tax benefit for married couples:

Community Property Step-Up Rules:

• Community property: Both halves get step-up when first spouse dies (even the surviving spouse's half)
• Separate property: Only deceased spouse's property gets step-up

Example of California community property step-up:

• Married couple owns California home (community property)
• Purchased in 1990 for $200,000
• Worth $1,200,000 when husband dies in 2025
• With community property rules: Entire $1,200,000 basis stepped up (wife's half + husband's half)
• If wife later sells for $1,200,000: $0 capital gains tax
• Tax savings: $200,000+ (would have been capital gains tax on $1 million appreciation)

Without community property rules (most other states): Only deceased spouse's half ($600,000) would get step-up. Wife would owe capital gains on her half's appreciation.

Assets That Get Step-Up in Basis

Assets that qualify for step-up:

• ✓ Real estate
• ✓ Stocks and bonds
• ✓ Mutual funds
• ✓ Collectibles
• ✓ Business interests
• ✓ Cryptocurrency

Assets that DON'T get step-up:

• ✗ IRAs and 401(k)s (retirement accounts)
• ✗ Annuities
• ✗ Tax-deferred accounts
• ✗ Savings bonds (in some cases)

Planning Strategy: Hold Appreciated Assets Until Death

The step-up in basis creates a powerful tax planning opportunity:

Strategy: If you own highly appreciated assets (stock, real estate), consider holding until death rather than selling during your lifetime.

Example:

• You own stock worth $1M with $100K basis (purchased for $100K, now worth $1M)
• If you sell during life: Pay $180,000+ capital gains tax (federal + California)
• If you hold until death: Heirs inherit at $1M basis, sell immediately, pay $0 tax
• Tax savings: $180,000+

Note: This only makes sense if you don't need the money. Don't let the "tax tail wag the dog."

Property Tax: Proposition 13 & Proposition 19 Explained

California's property tax rules are unique and critical to understand when planning your estate.

Proposition 13 Basics (1978)

Prop 13 limits property tax increases:

• Property tax = 1% of assessed value + local bonds
• Assessed value can only increase 2% per year maximum
• Reassessment occurs when property changes ownership
• Results in massive tax savings for long-term owners

Example of Prop 13 benefit:

• Home purchased in 1990 for $200,000
• Fair market value in 2025: $1,200,000
• Without Prop 13: Property tax on $1,200,000 = $12,000/year
• With Prop 13: Property tax on ~$350,000 (original $200K + 2%/year increases) = $3,500/year
• Annual savings: $8,500

Does a Living Trust Trigger Property Tax Reassessment?

Proposition 19 (2021): Major Changes to Parent-Child Transfers

Old Rules (Pre-February 16, 2021):

• Parents could transfer primary residence + $1M of other property to children without reassessment
• Children kept parents' low Prop 13 tax base
• No restrictions on how children used the property

New Rules (After February 16, 2021) - Prop 19:

• Primary residence: Transfer exempt from reassessment ONLY if:
  • Child uses as their primary residence
  • Value under $1M over parents' taxable value qualifies for exemption
  • Excess over $1M is reassessed
• All other property: Reassessed to fair market value (no exemption)

Prop 19 Examples

Example 1: Primary Residence (Child Lives There)

• Parents' home, Prop 13 assessed value: $300,000
• Fair market value: $1,200,000
• Child inherits and lives in home as primary residence
• Difference: $900,000 (under $1M threshold)
• Result: No reassessment, child keeps $300,000 assessed value
• Annual property tax: $3,000 (instead of $12,000 at market value)

Example 2: Primary Residence (Child Doesn't Live There)

• Parents' home, Prop 13 assessed value: $300,000
• Fair market value: $1,200,000
• Child inherits but rents it out or uses as vacation home
• Result: Full reassessment to $1,200,000
• Annual property tax: $12,000 (instead of $3,000)
• Property tax increase: $9,000/year

Example 3: Vacation Home or Rental Property

• Parents' rental property, Prop 13 assessed value: $400,000
• Fair market value: $1,000,000
• Child inherits
• Result: Full reassessment to $1,000,000 (no exemption)
• Annual property tax: $10,000 (instead of $4,000)
• Property tax increase: $6,000/year

Planning Around Prop 19

Option 1: Child moves into property - Only works for one primary residence, not vacation/rental properties.

Option 2: Sell before death - Parents sell property, avoid reassessment issue, but lose step-up in basis benefit.

Option 3: Gift during life - If you gifted property before February 16, 2021, old rules apply (no reassessment). Too late now.

Option 4: Accept the tax increase - Sometimes the property value appreciation and rental income outweigh the higher property taxes.

Option 5: Advanced trust strategies - Some irrevocable trust strategies may help, but require expert legal advice and giving up control.

Gift Tax Considerations

Transferring Assets to Your Living Trust: No Gift Tax

Gift Tax Basics (2025)

Annual exclusion: $19,000 per recipient (2025)

• Give up to $19,000 per person per year without filing gift tax return
• Unlimited number of recipients
• Example: Give $19,000 to each of your 3 children = $57,000 total (no gift tax return)

Lifetime exemption: $13.99 million (2025)

• Gifts over annual exclusion reduce your lifetime exemption
• Same exemption as estate tax
• Must file Form 709 (gift tax return) for gifts over annual exclusion

Married couples: Can double annual exclusion

• Each spouse gives $19,000 = $38,000 per recipient
• Example: Married couple gives $38,000 to child (no gift tax return)

Gifts That Don't Count Against Limits

Unlimited gifts for:

• ✓ Tuition paid directly to educational institution
• ✓ Medical expenses paid directly to healthcare provider
• ✓ Gifts to spouse (unlimited marital deduction)
• ✓ Gifts to charity

Irrevocable Trust Gift Tax Issues

Transferring assets to an irrevocable trust IS a taxable gift (unlike revocable trusts).

Example:

• Transfer $500,000 home to irrevocable trust
• Annual exclusion: $19,000
• Taxable gift: $481,000
• Reduces lifetime exemption from $13.99M to $13.51M
• Must file Form 709 (gift tax return)
• No immediate tax if under lifetime exemption

Tax Benefits Comparison Table

Tax Type	No Estate Plan	Will Only	Revocable Living Trust
Income Tax	Pay normal taxes	Pay normal taxes	Pay normal taxes
Capital Gains Tax	Heirs get step-up	Heirs get step-up	Heirs get step-up
Estate Tax (under $13.99M)	$0	$0	$0
Estate Tax (over $13.99M)	40% on excess	40% on excess	40% on excess
California Estate Tax	None (CA has no estate tax)	None	None
Property Tax (Prop 13)	Protected	Protected	Protected
Property Tax (Heirs under Prop 19)	Reassessed*	Reassessed*	Reassessed*
Probate Costs	$27K-$68K+	$27K-$68K+	$0
Time to Settle Estate	12-18 months	12-18 months	2-4 weeks

* Under Prop 19 (2021), primary residence transfer to children avoids reassessment only if child lives there and value under $1M over parent's base. All other property reassessed.

When Trusts DO Save Taxes (Irrevocable Trusts)

While revocable living trusts don't provide tax benefits, certain irrevocable trusts can significantly reduce taxes.

Types of Trusts That Provide Tax Benefits

1. Irrevocable Life Insurance Trust (ILIT)

Purpose: Remove life insurance proceeds from your taxable estate

How it works:

• Create irrevocable trust to own life insurance policy
• Trust is policy owner and beneficiary
• When you die, life insurance proceeds paid to trust
• Proceeds NOT included in your taxable estate

Tax savings example:

• Estate value: $12M
• Life insurance: $5M policy
• Without ILIT: Estate = $17M, tax on $3.01M excess = $1.2M estate tax
• With ILIT: Estate = $12M (insurance removed), $0 estate tax
• Tax savings: $1.2 million

Requirements:

• Trust must be irrevocable (can't change it)
• Can't be trustee
• Must survive 3 years after transferring existing policy to trust
• Use Crummey letters for annual premium gifts

2. Charitable Remainder Trust (CRT)

Purpose: Avoid capital gains tax on highly appreciated assets while generating income

How it works:

• Transfer appreciated asset (stock, real estate) to CRT
• Trust sells asset - pays NO capital gains tax
• Trust pays you income for life or term of years
• Remainder goes to charity when you die

Tax savings example:

• Stock purchased for $100K, now worth $1M
• Without CRT: Sell for $1M, pay $180K capital gains tax (federal + CA), net $820K to invest
• With CRT: Transfer to CRT, trust sells for $1M, pays $0 tax, full $1M invested, generates income
• Plus: Immediate income tax deduction for charitable remainder
• Tax savings: $180K+ capital gains avoided

3. Qualified Personal Residence Trust (QPRT)

Purpose: Transfer home to children at reduced gift tax value

How it works:

• Transfer home to irrevocable trust
• Retain right to live in home for term of years (e.g., 10 years)
• Gift value discounted because of retained interest
• At end of term, home passes to children

Tax savings example:

• Home worth $3M
• Direct gift: $3M gift, uses $3M of lifetime exemption
• QPRT (10-year term): $1.2M gift value (discounted), uses only $1.2M of exemption
• Benefit: Saves $1.8M of lifetime exemption

4. Grantor Retained Annuity Trust (GRAT)

Purpose: Transfer appreciating assets to heirs with minimal or zero gift tax

How it works:

• Transfer assets to irrevocable trust
• Trust pays you annuity for term of years
• Remaining appreciation passes to beneficiaries gift-tax free

Tax savings example:

• Transfer $5M stock to 2-year GRAT
• Stock appreciates to $7M
• GRAT pays you back $5M + IRS assumed return
• $2M appreciation passes to beneficiaries gift-tax free
• Estate tax savings: $800K (40% of $2M)

5. Medicaid Asset Protection Trust (MAPT)

Purpose: Protect assets from nursing home costs while qualifying for Medi-Cal

How it works:

• Transfer assets to irrevocable trust
• Wait 30 months (California Medi-Cal look-back period)
• Apply for Medi-Cal to cover nursing home
• Assets in trust protected from Medi-Cal recovery

Savings example:

• Transfer $500K home to MAPT
• Wait 30 months
• Enter nursing home, qualify for Medi-Cal
• Medi-Cal pays $150K/year nursing home costs
• Home protected from Medi-Cal estate recovery
• Savings: $500K home preserved + $150K/year care covered

When Trusts DON'T Save Taxes

Let's be crystal clear about when living trusts provide NO tax benefits:

Living Trusts DON'T Save Income Taxes

Common misconception: "I can put rental property in a trust and deduct more expenses."

Reality: Rental property in a trust gives you the exact same deductions as rental property owned personally.

• ✗ No additional deductions
• ✗ No special depreciation benefits
• ✗ No lower tax rates
• ✗ No income splitting

Living Trusts DON'T Save Estate Taxes (Under $13.99M)

Common misconception: "My estate is $2 million. A trust will help me avoid estate taxes."

Reality: Estates under $13.99 million pay ZERO estate tax regardless of trust, will, or nothing.

The $13.99M exemption applies whether you have:

• Revocable living trust
• Will only
• No estate plan

Living Trusts DON'T Reduce Capital Gains Taxes

Common misconception: "If I put appreciated stock in a trust, I won't pay capital gains tax when I sell."

Reality: You pay the exact same capital gains tax whether the stock is in your name or your trust's name.

• Stock owned personally: Sold for gain, pay capital gains tax on your Form 1040
• Stock in revocable trust: Sold for gain, pay capital gains tax on your Form 1040
• Zero difference

Living Trusts DON'T Reduce Property Taxes

Common misconception: "Putting my house in a trust will lower my property taxes."

Reality: Property taxes are identical whether your house is in your name or in your trust.

• Same Prop 13 assessed value
• Same annual property tax bill
• Zero property tax savings

Living Trusts DON'T Create Tax Deductions

Common misconception: "I can deduct the cost of creating a living trust."

Reality: Living trust creation costs are NOT tax deductible for individual taxpayers.

• Attorney fees: Not deductible
• Document preparation: Not deductible
• Notary fees: Not deductible

(Prior to 2018, some estate planning costs were deductible as miscellaneous itemized deductions. TCJA eliminated this deduction.)

Living Trusts DON'T Affect Gift Taxes

Common misconception: "I can give more to my children if I use a trust."

Reality: Same gift tax rules apply whether you give:

• Cash directly to children
• Assets from your trust to children

Both are subject to:

• $19,000 annual exclusion per recipient (2025)
• $13.99M lifetime exemption
• Form 709 filing requirement for gifts over annual exclusion

Tax ID/EIN Requirements for Living Trusts

Do You Need a Separate Tax ID for Your Living Trust?

Why Living Trusts Don't Need an EIN

IRS rules treat revocable living trusts as "grantor trusts," which means:

• Trust is disregarded for tax purposes
• You are treated as the owner
• Use your SSN (not a separate EIN)
• No separate trust tax return required

Using Your SSN for Trust Accounts

Bank accounts titled in trust name:

• Account title: "John Smith, Trustee of the John Smith Living Trust dated January 15, 2025"
• Tax ID on account: Your Social Security Number
• 1099-INT issued to: John Smith (using your SSN)
• You report interest on your Form 1040

Investment accounts titled in trust name:

• Account title: "Jane Doe Living Trust dated March 10, 2025, Jane Doe TTEE"
• Tax ID on account: Your Social Security Number
• 1099-DIV and 1099-B issued to: Jane Doe (using your SSN)
• You report on your Form 1040

When You DO Need an EIN

You need to obtain an EIN (Employer Identification Number) for your trust when:

1. After you die: Trust becomes irrevocable, requires separate EIN
   • Successor trustee applies for EIN
   • Trust files Form 1041 during estate settlement
   • Bank and investment accounts updated with trust EIN
2. If you become incapacitated: Some institutions require EIN when successor trustee takes over
   • Not always required
   • Check with specific bank/institution
   • IRS allows continued use of SSN in some cases
3. If trust owns a business: Business operations may require EIN
   • Trust operates active business
   • Employees paid by trust
   • Certain business licenses require EIN
4. If you convert to irrevocable trust: Intentional conversion requires EIN
   • Rare situation
   • Usually done for Medicaid planning
   • Trust becomes separate taxpayer

How to Get an EIN (When Needed)

When you need an EIN after death or incapacity:

1. Online application: Go to IRS.gov and search "Apply for EIN"
2. Complete Form SS-4: Application for Employer Identification Number
3. Select trust type: "Estate" or "Trust" (select "Decedent's Estate" for post-death)
4. Receive EIN immediately: Online applications get instant EIN
5. No cost: IRS EIN application is free

What Banks and Financial Institutions Need

When opening accounts in your living trust name:

1. Trust certification (abstract of trust): 2-3 page summary showing:
   • Trust name and date
   • Trustee name and powers
   • Signature authority
2. Your driver's license: Trustee identification
3. Your Social Security Number: For IRS Form W-9
4. NO EIN needed (unless trust is irrevocable)

Most banks are familiar with living trusts. Provide the trust certification and your SSN, and they'll set up the account properly.

Real-Life Tax Scenarios

Let's examine real-world scenarios showing actual tax implications:

Scenario 1: Typical California Homeowner

Scenario 2: High Net Worth Individual

Scenario 3: Retiree Planning for Nursing Home

Scenario 4: Couple with Vacation Home

Common Tax Misconceptions Debunked

Misconception #1: "Trusts are tax shelters"

The myth: Living trusts help you hide income or avoid taxes.

The reality: Revocable living trusts are completely transparent to the IRS. You report all income on your personal tax return. The trust provides zero tax shelter benefits.

Actual tax shelters: Qualified retirement accounts (401k, IRA), HSAs, 529 plans - NOT living trusts.

Misconception #2: "I won't have to pay capital gains tax if property is in a trust"

The myth: Trust-owned property can be sold without capital gains tax.

The reality: You pay the exact same capital gains tax whether you own property personally or through your revocable living trust. There is zero difference.

Example:

• Stock purchased for $100K, now worth $300K
• Personal ownership: Sell for $300K, pay ~$40K capital gains tax
• Trust ownership: Sell for $300K, pay ~$40K capital gains tax (NO DIFFERENCE)

Misconception #3: "My heirs won't pay inheritance tax with a trust"

The myth: Living trusts help heirs avoid inheritance taxes.

The reality: California has NO inheritance tax (whether you have a trust or not). And federal estate tax only applies to estates over $13.99M. For 99.9% of families, there is zero inheritance/estate tax with or without a trust.

Misconception #4: "Trust income is taxed at lower rates"

The myth: Trust income enjoys special low tax rates.

The reality: The opposite is true for irrevocable trusts! Trust tax brackets are compressed:

• Individual: 37% top rate starting at $609,350 income
• Trust: 37% top rate starting at $15,200 income

Trusts reach the highest tax bracket 40x faster than individuals.

And for revocable living trusts, all income is taxed at YOUR individual rates (not separate trust rates).

Misconception #5: "I can deduct trust creation costs"

The myth: Attorney fees for creating a living trust are tax deductible.

The reality: Trust creation costs are NOT deductible on your personal tax return. These are personal expenses, not business expenses.

(Note: Before 2018, some estate planning costs were deductible as miscellaneous itemized deductions subject to 2% AGI floor. The Tax Cuts and Jobs Act eliminated this deduction.)

Misconception #6: "Trusts help you avoid property taxes in California"

The myth: Putting your house in a trust reduces property taxes.

The reality: Property taxes remain identical whether your house is in your name or your trust. Same Prop 13 assessed value, same annual bill.

Transferring to trust does NOT trigger reassessment: California Revenue & Taxation Code Section 62(d) specifically exempts trust transfers from reassessment.

Misconception #7: "Business assets in a trust get better tax treatment"

The myth: Moving business interests to a trust provides tax advantages.

The reality: Business income from trust-owned interests is taxed identically to personally-owned interests.

• LLC interest in trust: Income flows through to your Form 1040
• LLC interest owned personally: Income flows through to your Form 1040
• Zero difference

Misconception #8: "Trusts protect assets from taxes"

The myth: Creating a trust shields assets from IRS taxation.

The reality: The IRS can reach trust assets for tax debts just as easily as personally-owned assets. Revocable living trusts provide zero asset protection from IRS or other creditors.

Only properly structured irrevocable trusts (created before debts arise) provide asset protection.

Misconception #9: "I need a trust to avoid the estate tax"

The myth: Everyone needs a trust to avoid estate taxes.

The reality: 99.9% of estates owe ZERO estate tax (under $13.99M exemption). You don't need a trust to avoid estate tax because there is no tax to avoid for typical families.

What you DO need a trust for: Avoiding $27,000-$68,000+ in probate costs.

Misconception #10: "Charitable trusts provide immediate tax deductions"

The myth: Creating a living trust with charitable beneficiaries gives you tax deductions now.

The reality: You only get charitable deductions when:

• You make an actual donation (transfer assets irrevocably to charity or charitable trust)
• Naming charity as beneficiary in your revocable living trust = NO current deduction
• Charitable remainder trust (CRT - irrevocable) = YES, immediate partial deduction

Frequently Asked Questions About Living Trust Taxes

Do I have to file a separate tax return for my living trust?

No. Revocable living trusts do not file separate tax returns. You report all trust income on your personal Form 1040, just as you did before creating the trust. The trust is "invisible" to the IRS during your lifetime.

Will a living trust reduce my income taxes?

No. A revocable living trust provides zero income tax reduction. You pay exactly the same income taxes as if you owned assets personally. The trust is tax-transparent.

Can I deduct the cost of creating a living trust?

No. Trust creation costs (attorney fees, document preparation) are not tax deductible on your personal tax return. These are personal expenses.

Do I need a tax ID number (EIN) for my living trust?

No. Use your Social Security Number for your revocable living trust. You only need an EIN after you die (when the trust becomes irrevocable) or if you become incapacitated.

Will my heirs pay less tax if I have a living trust?

No. Your heirs receive the same step-up in basis and pay the same taxes regardless of whether you have a trust, a will, or nothing. The tax treatment is identical.

Does California have an estate tax or inheritance tax?

No. California has no state estate tax or inheritance tax. Only federal estate tax applies (for estates over $13.99M in 2025). California eliminated its estate tax in 2005.

What is the federal estate tax exemption for 2025?

$13.99 million per person ($27.98M for married couples with portability). Only estates exceeding this amount owe federal estate tax at 40% on the excess. This high exemption means 99.9% of estates owe zero estate tax.

Will the estate tax exemption decrease in 2026?

Yes, probably. Under current law, the exemption is scheduled to be cut approximately in half to around $7 million on January 1, 2026 (unless Congress extends the current higher exemption). If you have an estate over $7M, consult an estate planning attorney now.

Does transferring my house to a trust trigger property tax reassessment?

No. Transferring property to your revocable living trust does NOT trigger Prop 13 reassessment. Your property taxes remain unchanged. California law (Revenue & Taxation Code Section 62(d)) specifically exempts these transfers.

What is Proposition 19 and how does it affect property taxes?

Prop 19 (effective February 16, 2021) limits the parent-child property tax transfer exemption. Now:

• Primary residence: Transfer to child avoids reassessment ONLY if child moves in and value under $1M over parent's base
• All other property: Reassessed to fair market value (vacation homes, rentals, etc.)
• Trust impact: Prop 19 applies equally whether parent used trust, will, or no plan

Do living trusts help with capital gains taxes?

No. You pay the same capital gains tax whether assets are owned personally or in your revocable living trust. However, assets in the trust DO receive step-up in basis at death (eliminating capital gains on appreciation during your life).

What is step-up in basis and does a trust affect it?

Step-up in basis resets the cost basis of inherited assets to fair market value at death, eliminating capital gains tax on lifetime appreciation. Living trusts do NOT affect step-up in basis - your heirs get the same benefit with or without a trust.

Are there any trusts that DO provide tax benefits?

Yes, but only irrevocable trusts:

• Irrevocable Life Insurance Trust (ILIT): Removes life insurance from taxable estate
• Charitable Remainder Trust (CRT): Avoids capital gains tax on donated assets
• Grantor Retained Annuity Trust (GRAT): Transfers appreciation gift-tax free
• Qualified Personal Residence Trust (QPRT): Reduces gift tax on home transfers

All irrevocable trusts require permanently giving up control of assets.

Should I create a trust for tax reasons?

No. Create a revocable living trust to avoid probate (saving $27K-$68K+ and 12-18 months), not for tax reasons. Most families receive zero tax benefits from trusts, but massive probate savings.

When my trust distributes assets to beneficiaries, do they owe tax?

Depends on the asset type:

• Real estate, stocks, other capital assets: Beneficiaries receive with step-up in basis, no immediate tax (tax only if they sell later)
• Retirement accounts (IRA, 401k): Beneficiaries owe income tax as they withdraw (no step-up for retirement accounts)
• Cash: No income tax (already after-tax money)

Can I transfer property into my trust without paying gift tax?

Yes. Transferring your property into your revocable living trust is NOT a taxable gift because you still own and control the assets. No gift tax return required.

What's the difference between estate tax and inheritance tax?

• Estate tax: Tax on the estate of the deceased (paid before distribution to heirs). Federal estate tax applies to estates over $13.99M. California has no state estate tax.
• Inheritance tax: Tax paid by the person receiving an inheritance. California has no inheritance tax.
• Result: Most Californians pay zero estate or inheritance tax.

Do trust distributions to beneficiaries count as income?

After death (during estate settlement):

• Principal distributions: No income tax (inherited money/property)
• Income earned by trust: Taxable to beneficiaries (reported on K-1)

Example: Trust earns $10K interest before distributing. Beneficiary receives $10K and owes income tax on it.

How are retirement accounts in a trust taxed?

Important: You typically should NOT transfer retirement accounts (IRA, 401k) into your living trust during your lifetime. Instead:

• Name the trust as beneficiary of the retirement account
• At death, retirement account pays to trust
• Trust then distributes to beneficiaries per your instructions
• Beneficiaries owe income tax as they withdraw from inherited retirement accounts

Can I put my business in a trust? What are the tax implications?

Yes, you can transfer business interests to your trust (LLC interests, corporate stock, partnership interests). Tax implications:

• Same income tax treatment (business income flows through to your Form 1040)
• No change to business deductions or tax filing
• Avoids probate of business interests at death
• Zero tax impact during your lifetime

Is trust income taxed at different rates than personal income?

Revocable living trust: All income taxed at your individual rates (trust is transparent).

Irrevocable trust (after death): Trust files Form 1041 and pays tax at compressed trust rates (reaching 37% top bracket at just $15,200 income).

Disclaimer: This article provides general information about California living trusts and tax implications and should not be considered legal or tax advice. Tax laws are complex and change frequently. For specific estate planning or tax guidance, consult with a licensed California estate planning attorney or qualified tax professional. Tax figures, exemption amounts, and laws are current as of January 2025 and subject to change.