Tax Consequences of Transferring Stock to a Trust

Transferring stock into a trust is a common strategy for managing assets and planning for the future. This process involves changing the legal ownership of your shares to a trustee, who manages the assets for your chosen beneficiaries. The tax consequences of this action are a significant factor, and the tax treatment depends almost entirely on the structure of the trust you establish. The rules governing these transfers have different outcomes for the person creating the trust, the trust entity itself, and the eventual beneficiaries.

Tax Treatment of Grantor Trusts

When stock is transferred into a grantor trust, which is most often a revocable living trust, the IRS essentially disregards the trust for income tax purposes. This means the grantor and the trust are viewed as one and the same taxpayer.

Because the grantor retains control over the assets, the initial transfer of stock into this type of trust is not a taxable event. No capital gains or gift tax is triggered by retitling the shares in the trust’s name. All income generated by the stock held within the grantor trust continues to be reported on the grantor’s personal income tax return, Form 1040. The trust itself generally does not file its own separate income tax return.

The cost basis of the stock, which is the original purchase price, does not change when it is moved into a grantor trust, as the trust assumes the grantor’s existing basis. A significant tax benefit of this structure occurs at the grantor’s death. The assets held within the revocable trust receive a “step-up” in basis to their fair market value on the date of the grantor’s death. This means that if the beneficiaries inherit the stock and sell it immediately, they would owe little to no capital gains tax.

For example, if stock was purchased for $100,000 and is worth $1 million at the grantor’s death, the basis for the heirs becomes $1 million. A subsequent sale at that price would result in no taxable gain.

Tax Consequences of Non-Grantor Trusts

A non-grantor trust, typically an irrevocable trust, operates as a distinct legal and taxable entity separate from its creator. When you transfer stock into this type of trust, you are making a completed gift because you have relinquished control over the assets. This transfer has immediate gift tax implications, with the value of the gift being the fair market value of the stock on the date of the transfer.

For 2025, you can use your annual gift tax exclusion of $19,000 per recipient, and a married couple can jointly gift up to $38,000 per recipient. If the value of the stock transferred exceeds the annual exclusion amount, you must file a federal gift tax return, Form 709. While you may not owe tax immediately, the amount of the gift that exceeds the annual exclusion will reduce your lifetime gift and estate tax exemption.

Because a non-grantor trust is a separate taxpayer, it must obtain its own Taxpayer Identification Number (TIN) and file its own annual income tax return, Form 1041. A feature of trust income taxation is its highly compressed tax brackets. Undistributed income retained by the trust is taxed at rates that escalate much more quickly than for individuals. For instance, in 2025, a trust pays 10% on its first $3,150 of undistributed income, but the rate quickly jumps to 37% on income over $15,650.

To manage the trust’s tax liability, the concept of Distributable Net Income (DNI) is used. DNI is a calculation that determines the maximum amount of income the trust can deduct if it distributes funds to beneficiaries. When the trust makes distributions, it passes the income and the corresponding tax liability to the beneficiaries, who report that income on their personal tax returns.

Capital Gains and Basis

When stock is gifted to a non-grantor trust, the trust’s basis in the stock is determined by a “carryover basis” rule. This means the trust takes on the grantor’s original cost basis in the stock. This is a contrast to the step-up in basis that assets in a grantor trust receive at the grantor’s death. The carryover basis has significant implications for capital gains tax when the trust eventually sells the stock.

For example, if a grantor transfers stock with a basis of $50,000 and a current market value of $500,000 to a non-grantor trust, the trust’s basis in that stock is $50,000. If the trustee later sells the stock for $550,000, the trust will realize a capital gain of $500,000, calculated from the original carryover basis. This gain will be taxed at the trust’s compressed tax rates if it is not distributed to the beneficiaries in the same year.

Tax Implications for Beneficiaries

The tax consequences for beneficiaries of a trust depend on the nature of the distributions they receive. When a trust distributes income to a beneficiary, that income generally retains its character and is taxed to the beneficiary. The trust provides the beneficiary with a Schedule K-1, a tax form that details the amount and type of income being distributed. The beneficiary then reports this information on their personal Form 1040 and pays the corresponding tax at their individual income tax rate. This system ensures that the income generated by the trust’s assets is taxed only once, either at the trust level if accumulated or at the beneficiary level if distributed.

A different set of rules applies when a beneficiary receives a distribution of the trust’s principal, which is the original property placed in the trust. Distributions of principal are generally not taxable to the beneficiary. For example, if the trust distributes the actual shares of stock to a beneficiary, this is considered an “in-kind” distribution of principal. The beneficiary does not owe income tax upon receiving the shares. When a beneficiary receives an in-kind distribution of stock, they also receive the stock’s basis as it was held by the trust, and will be responsible for the capital gains tax if they decide to sell the shares.

Estate and Generation-Skipping Transfer Tax Considerations

A primary motivation for transferring stock to a non-grantor irrevocable trust is to remove those assets from the grantor’s taxable estate. Once the stock is transferred to a properly structured irrevocable trust, it is no longer considered part of the grantor’s estate upon their death. This means the value of the stock, and any future appreciation, will not be subject to estate tax.

The federal estate tax exemption allows $13.99 million per person in 2025 to be passed to heirs tax-free. It is important to note that this high exemption amount is scheduled to be cut by about half at the end of 2025. By making lifetime gifts to an irrevocable trust, a person can effectively reduce the size of their taxable estate.

An additional layer of tax to consider is the Generation-Skipping Transfer (GST) tax. This tax is imposed on transfers of wealth to beneficiaries who are two or more generations younger than the grantor, such as grandchildren. The GST tax is a flat tax applied at the highest estate tax rate, in addition to any applicable gift or estate tax. Each individual has a lifetime GST tax exemption, which for 2025 is also $13.99 million. By allocating the exemption to assets transferred into the trust, the trust becomes “GST exempt,” meaning that distributions from the trust to these beneficiaries will not be subject to the GST tax.