How Does Maryland Tax Trusts?

In estate planning, trusts play a vital role in managing and distributing assets. In Maryland, trusts are governed by many laws and regulations, but arguably the most important are those governing taxation on trusts.

Residents of Maryland are subject to tax on all income, regardless of its source. This means that you will likely need to pay taxes on a trust that derives value from the state. In addition to Maryland tax responsibilities, you might also need to report your trust to the IRS. While this might seem financially draining, deductions and exemptions are in place to help save money.

For a free case review with our Maryland trust attorneys, call Rice, Murtha & Psoras at (410) 694-7291.

How Are Trusts Taxed in Maryland?

A trust is a legal arrangement that allows a person, known as the “settlor,” “grantor,” or “transferor,” to transfer legal ownership of specific property to another person, known as the “trustee,” for the benefit of a third person, known as the “beneficiary.” Trusts are a popular estate planning tool that can be used for various purposes, such as passing property to beneficiaries, managing assets for minors or individuals with special needs, and minimizing taxes.

What is a Trust?

Trusts offer a great deal of flexibility and can be tailored to meet the specific needs of the settlor and beneficiaries. For instance, trusts can be created for charitable or private purposes, and they can be revocable or irrevocable. Additionally, trusts can be established during the settlor’s lifetime, known as a “living” or “inter vivos” trust, or at the settlor’s death, known as a “testamentary” trust. Trusts can be a faster and more cost-effective way to transfer property than a will, making them an attractive option for many people.

As the settlor, you are treated as the owner of the trust assets during your lifetime. As a result, all the income the trust assets generate is included in your income. Similarly, upon your death, the trust assets are included in your estate for federal and Maryland estate tax purposes.

Taxing Trusts in Maryland

As it is considered part of an individual’s income, trusts are subject to both federal and state tax requirements. While the overlap can be challenging to understand, our Maryland tax attorneys are here to help guide you through the process so that you do not face any unintended tax consequences. While a revocable trust does not provide any income tax benefits during your lifetime, it can offer estate tax advantages upon your death.

One of the key benefits of a revocable trust is that it allows you to change the state that has the authority to tax the trust’s income. For instance, if you created the trust in Maryland but later moved to another state, you might be able to change the jurisdiction of the trust to your new state of residence. This could potentially reduce state income taxes and provide greater flexibility in managing your estate.

Do I Need to File an Income Tax Return for a Trust in Maryland?

Trusts are treated as separate entities for tax purposes in Maryland. This means that the income generated by the trust is subject to state income tax. To comply with Maryland tax laws, trusts are required to file a Fiduciary Income Tax Return, Form 504, if they meet certain criteria.

If the trust has gross income that comes from sources within Maryland or if it has net income from sources within Maryland, it must file a state return. Additionally, if there are no resident beneficiaries associated with the trust, it must file a state return.

In addition to a Maryland state income tax return, you might also need to file a federal income tax return. The Internal Revenue Service (IRS) requires a trust to file Form 1041, U.S. Income Tax Return for Estates and Trusts, if the trust has a gross income of $600 or more during the tax year. Additionally, if the trust has any amount of taxable income, it must file taxes as well. Lastly, if the trust has a nonresident alien beneficiary, it must also file taxes.

Even if a trust fails to meet the mandatory tax filing requirements criteria, it is still recommended to file a tax return to ensure compliance with state and federal tax laws and report any income generated by the trust. This approach can prevent potential legal and financial complications in the future.

What Are the Tax Rates for Trusts in Maryland?

In Maryland, trusts are subject to a progressive income tax rate structure similar to the one applied to individual taxpayers. The tax rates for trusts in Maryland for the tax year 2023 range from 2% to 5.75%.

The specific tax rate that applies to a trust is determined by its taxable income. This means trusts with higher taxable income will be subject to a higher tax rate, while those with lower taxable income will be subject to a lower tax rate. Keep in mind that the tax rates for trusts in Maryland are subject to change, so it is advisable to stay up-to-date with the latest tax laws and regulations.

Are There Deductions or Exemptions for Trust Taxes in Maryland?

Trusts in Maryland are allowed to take deductions and exemptions when calculating their taxable income. The following are common deductions and exemptions available to trusts in Maryland:

Personal Exemption

Trusts are eligible for a personal exemption deduction on their tax returns. The deduction amount is calculated based on the number of beneficiaries associated with the trust and their residency status. The greater the number of beneficiaries, the higher the personal exemption deduction. Conversely, trusts with more foreign beneficiaries might receive a lower deduction or no deduction at all.

Administrative Expenses

Trusts are also allowed to deduct reasonable and necessary expenses that were incurred during the administration of the trust from its taxable income. This means that expenses such as legal fees, accounting fees, trustee fees, and other expenses that are directly related to the management and operation of the trust can be deducted. However, any expenses that are not directly related to the administration of the trust cannot be deducted.

Charitable Contributions

A trust can potentially receive a deduction if it chooses to make qualified charitable contributions. However, Trusts should ensure they have met all the necessary criteria before making contributions to ensure they are eligible for this deduction.

Our Maryland Tax Attorneys Can Help Determine the Taxes Due on Your Trust

Call Rice, Murtha & Psoras at (410) 694-7291 for a free assessment of your case with our Ellicott City, MD trust lawyers.