Taxation of Trusts

Trust is a right on property, real or personal, held by one party for the benefit of another. Trust also
refers to a legal instrument or device whereby a person called a Trustor or Grantor delivers part or all of
his properties to another person called Trustee or Fiduciary who administer and manages the
property/ies for the benefit of designated person/s called Beneficiaries. The term “person” may refer to
an individual or natural person or a judicial person like a corporation.

Trust may be arranged inter-vivos or created by will under which title to a property is passed to another
for conservation or investment with the income therefrom and ultimately the corpus (principal) to be
distributed in accordance with the directions of the creator as expressed in the governing instrument.

The subject matter of the trust must be clearly identified. It is important that the property to be
transferred in trust must be existing, lawful, definite and transferrable. Anything that has an economic
value and which a person may own and to which he may own and to which he may transfer legal title,
by gift or sale, is a property that may be conveyed in trust such as cash, stocks, bonds, real property,
livestock and growing crops and jewelry.

Trust agreement allows individuals to created sustained benefits for an individual or entity. For instance,
a parent may place a sum of money, property or other types of financial assets such as equity and debt
instruments in the hands of a trustee for the benefit of an incapacitated or minor child.

Parties to the Trust

1. Trustor – Person who establishes a trust.

2. Trustee – One in whom confidence is reposed as regards property for the benefit of another
person.
Fiduciary – Any person or corporation that holds in trust an estate of another person or persons.
3. Beneficiary – Person for whose benefit trust is created.

Taxability of Income of Trusts

The income of a trust may be taxable to the trustee, beneficiary or grantor, as the case may be.

Taxable to the “Trustee” if:

The income of the trust is taxable to the “trustee” if the income is to be accumulated or held for future
distribution, whether ordinary income or gain from sale of assets included in the corpus of the trust. The
imposition of the tax is not affected by the fact that the ultimate beneficiary may be a person exempt
from tax. Likewise, the income of a trust administered in a foreign country is taxable to the trustee.

Taxable to the “Grantor/Trustor” if:

 Under term of the trust, the title to any part of the corpus or principal of the trust may be
revested to the grantor (Revocable Trust). The income of the corpus or principal that may be
revested to grantor shall be taxable to the grantor.
  The income of the trust may be held or distributed for the benefit of the grantor.
 Under the term of the trust, the income of the trust shall be applied for the benefit of the
grantor.

Taxable to the Beneficiaries

The income of the trust is taxable to the beneficiaries if the income is to be distributed to the
beneficiaries. In such a case, the beneficiaries include in their return, their distributive share in the net
income of the trust. The distribution of the year’s income to an heir or beneficiary is a special item of
deduction for the trust. At the same time, the income distributed (actual or constructive) shall be
treated as a special item of income to the heir/beneficiary.

Special Deductions:

1. Distribution of the year’s income to an heir or beneficiary; and

2. Amount collected by a guardian of an infant which is to be held or distributed as the court may
direct.

Special deductions are not allowed in case of a trust administered in a foreign country.

The principles applied in computing the taxable income of an estate, is also applicable in the
determination of the taxable income of a trust. Hence, the Trust’s taxable income is likewise computed
in the same manner as an individual taxpayer. The tax due is also based on the graduated rates provided
under Section 24(A) of the Tax Code. Moreover, calendar period shall be used as accounting period for
tax purposes. A trust is required to adopt the calendar year as its accounting period.

Shown below is the pro-forma computation of the taxable income of a Trust and a Beneficiary:

Taxable income of the Trust

Gross Income Pxxx

Less: Deductions
Business Expenses Pxxx
Special Deduction:
Distribution of trust’s income to beneficiaries xxx
Taxable Income of the Trust Pxxx
Tax Due (Graduated Tax Rate) Pxxx

Taxable income of the Beneficiary

Compensation Income, if any

Net income of the beneficiary from business Pxxx
and/or practice of profession
Add:
Amount received from the income of the trust xxx
Taxable income of the Beneficiary Pxxx
Tax Due (Graduated Tax Rate) Pxxx
Classification of Trusts

1. Ordinary Trust - the income and corpus of the trust do not revert to the grantor. The trust
income is accumulated and held for distribution to the beneficiaries. Under the Tax Code,
ordinary trust is any of the following trusts:

 A trust where the income is accumulated or held for future distribution under the terms
of a will trust.
 A trust where the income is to be distributed currently by the fiduciary to the
beneficiaries
 A trust where the income is accumulated for the benefit of unborn or unascertained
person or persons with contingent interest.
 A trust where the income collected by a guardian of an infant is held or distributed as
the court may direct; and
 A trust where the income, is at the discretion of fiduciary, may be either distributed to
the beneficiaries or accumulated
2. Revocable Trust (Section 63-NIRC) - a trust where at any time, the power to revest in the
grantor, title to any part of the corpus of the trust is vested:

 In the grantor either alone or in conjunction with any person not having a substantial
adverse interest in the disposition of such part of the corpus of the income therefrom;
or
 In any person not having a substantial adverse interest in the disposition of such part of
the corpus or the income therefrom.

The income of such part of the trust shall be included in computing the taxable income of the grantor
(Sec. 63, NIRC)

3. Employees’ Trust - income tax shall not apply to employee’s trust which forms part of pension,
stock bonus, or profit-sharing plan of an employer for the benefit of some or all of his
employees (Section 60(B)-NIRC). The income of an employees’ trust is likewise exempt from the
payment of final taxes as well as income derived from the sale of real property whose funds are
sourced from the employees’ trust fund.

Requisites or Conditions for Exemption of Employee’s Trust

 The employee’s trust must form part of a pension, stock bonus, or profit-sharing plan of an
employer for the benefit of some or all of his employees;
 Contributions are made to the trust by such employer, or employees, or both;
 The contributions are made for the purpose of distributing to such employees the earnings and
principal of the fund accumulated by the trust in accordance with such plan.
 Under the trust instrument, it is impossible at any time prior to the satisfaction of all liabilities
with respect to employees under the trust, for any part of the corpus or income to be (within
the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive
benefit of his employees.
Any amount actually distributed to any employee or distribute shall be taxable to him in the year of
distribution, to the extent that it exceeds the amount contributed by such employee or distribute.

Consolidated Income Tax Returns (Two or more trusts)

Where two or more trusts is created by the same trustor or grantor and the beneficiary is the same
person, the following rules shall apply:

1. The taxable income of all the trusts shall be consolidated and the tax computed on such
consolidated income. The tax computed on the consolidated income shall be apportioned to the
different trusts, such that each trust shall have a share in the income tax on consolidated
income.

The format of computation follows (Tax Apportionment):

Taxable income of the trust Consolidated

Tax Apportioned to a trust = Taxable income of all trusts x income tax

2. Such proportion of said tax shall be assessed and collected from each trustee which the taxable
income of the trust administered by him bears to the consolidated income of the several trusts.
Each trust shall pay an income tax still due or payable computed as follows:

Income Tax apportioned to a trust Pxxx

Less: Income tax already paid (xxx)
Income Tax Payable Pxxx

Reference: Income Taxation 2022 Edition by Enrico D. Tabag and Earl Jimson R. Garcia