How Do Revocable Trust Tax Rates Work?

A revocable living trust allows an individual, the grantor, to place assets into a trust for management during their lifetime and distribution after death. A motivation for this trust is to avoid probate, which can be a public, costly, and time-consuming court process. While effective for asset management and probate avoidance, a revocable trust has tax consequences that change significantly after the grantor dies. The tax rules that apply during the grantor’s life are different from those that take effect after the grantor passes away.

Taxation of a Revocable Trust During the Grantor’s Lifetime

While the grantor is alive, a revocable trust is considered a “grantor trust” under federal tax law, meaning it is disregarded by the IRS for income tax purposes. The trust does not pay its own income taxes. Instead, all income, deductions, and tax credits from trust assets are reported on the grantor’s personal Form 1040 tax return.

The trust does not need to file its own annual income tax return and uses the grantor’s Social Security Number as its taxpayer identification number. Because of this, there is no separate trust tax rate during the grantor’s life. The income from the trust’s assets is taxed at the grantor’s individual income tax rates.

This tax treatment exists because the grantor can revoke or amend the trust at any time. Since the grantor retains full control over the assets, the IRS views them as the owner for income tax purposes. This makes creating a revocable trust a tax-neutral event during the grantor’s life.

Taxation After the Grantor’s Death

When the grantor dies, the tax identity of a revocable trust changes. The trust becomes irrevocable, meaning its terms can no longer be changed. At this point, the trust becomes a separate taxable entity with new administrative responsibilities for the successor trustee.

The successor trustee must obtain a new Taxpayer Identification Number (TIN) from the IRS for the trust. The trust can no longer use the deceased grantor’s Social Security Number. From this point on, the trust must file its own annual income tax return, Form 1041, U.S. Income Tax Return for Estates and Trusts. This filing is required if the trust has any taxable income or a gross income of $600 or more for the year.

The trust is now subject to the income tax brackets that apply to trusts and estates. For 2025, the federal income tax brackets for trusts are:

• 10% on income between $0 and $3,150
• 24% on income from $3,150 to $11,450
• 35% on income from $11,450 to $15,650
• 37% on income over $15,650

This structure means that a modest amount of retained income can push a trust into the top tax bracket.

For example, if a trust earns $20,000 in income and does not distribute it, a portion of that income will be taxed at 37%. In contrast, a single individual would need taxable income over $626,350 to reach that same 2025 tax bracket. This compression creates an incentive for trustees to distribute income to beneficiaries annually.

Beneficiaries will likely be in lower personal income tax brackets. When income is distributed, the trust can take a deduction for the distribution. The income is then reported and taxed on the beneficiaries’ personal returns via a Schedule K-1 issued by the trust.

Federal Estate Tax and Asset Basis Implications

The income tax owed by the trust is different from the federal estate tax. While a revocable trust avoids probate, it does not avoid the estate tax. Assets in a revocable trust at the time of death are included in the grantor’s gross estate for calculating the estate tax, which is a tax on the transfer of wealth.

The federal estate tax affects a small percentage of the population due to a high exemption amount. For individuals who die in 2025, the federal estate tax exemption is $13.99 million. An estate, including assets in a revocable trust, will not owe federal estate tax unless its value exceeds this amount. For married couples, this exemption is doubled to $27.98 million.

A tax benefit for assets in a revocable trust is the “step-up in basis” at the grantor’s death. An asset’s basis is its original purchase price, and capital gains tax is owed on the difference between the sale price and the basis. The step-up rule adjusts the basis of inherited assets to their fair market value on the date of the grantor’s death.

For example, if a grantor purchased stock for $50,000 that was valued at $500,000 at their death, the beneficiaries inherit the stock with a new basis of $500,000. If they sell the stock for that price, they would owe no capital gains tax. This provision can result in tax savings for heirs who inherit appreciated assets.

State Tax Considerations

Successor trustees and beneficiaries must also consider state-level tax laws. After the grantor’s death, the trust may be subject to state income tax. The rules for how a trust’s income is taxed vary by state, depending on the location of the trustee, the residence of the beneficiaries, and where the income is sourced.

Many people are more likely to encounter state-level estate or inheritance taxes than the federal version. An estate tax is paid by the decedent’s estate before assets are distributed. An inheritance tax is levied on the beneficiaries who receive the assets, and some states impose one or both of these taxes.

Exemption amounts for state taxes are often lower than the federal exemption, with some states having exemptions as low as $1 million. This means more estates will be subject to a state-level transfer tax. Tax rates and rules differ widely, and with inheritance taxes, the heir’s relationship to the decedent can impact the tax rate.