How Are Trusts Taxed in North Carolina?

Trusts manage and protect assets for family, friends, or charitable organizations. But once a trust is in place, will it be on the hook for taxes in North Carolina? This blog explains the tax responsibilities of trusts in North Carolina for both residents and non-residents. If you need help from a trust formation attorney in Wilmington, NC or the surrounding areas, please get in touch. We would be happy to speak with you free of charge about your estate planning needs and goals.

Resident vs. Non-Resident Trusts in North Carolina

Resident Trusts

North Carolina taxes trusts based on residency. A trust qualifies as a North Carolina “resident trust” if the grantor (the person creating the trust) lives in the state, or if the trust’s income is managed there. Resident trusts are subject to state income tax on all income, regardless of where it originates.

Non-Resident Trusts

Non-resident trusts, on the other hand, are taxed only on income that comes from sources within North Carolina. This distinction is important! We often help clients work through resident vs. non-resident trusts at Bespoke Estate Law. The North Carolina Department of Revenue’s guidelines on trust taxation provide further detail on the taxation of non-resident trusts.

Types of Trusts and Their Tax Implications

Taxation of Revocable Trusts in NC

Revocable trusts, sometimes called living trusts, allow the grantor to make changes or even dissolve the trust entirely. Because these trusts remain under the control of the grantor, they are generally taxed as part of the grantor’s personal income. This setup means that the owner of the trust must pay taxes on the income earned from the trust.

Taxes on Irrevocable Trusts in NC

Irrevocable trusts remove that tax burden. Once the grantor establishes an irrevocable trust, they typically relinquish control of the assets to a third party trustee. The benefit is that the irrevocable trust shifts the tax burden from the grantor to the trust itself. The trust files its own tax return and pays taxes on any income earned, based on North Carolina tax rates. As mentioned above, you should not wade into the murky waters of trust formation without an experienced trust attorney. Schedule a free consultation with us today if you live in NC or SC.

State and Federal Income Tax on Trusts in NC

North Carolina’s flat income tax rate applies to both resident and non-resident trusts. Currently, this rate is applied to all taxable income earned by the trust, regardless of the type of income (interest, dividends, capital gains). If you have a trust in NC with beneficiaries in different states, speak with a CPA on how you can optimize this income for tax purposes.

Your trust may also face federal taxation. The IRS taxes trusts on income earned over a certain threshold – when some trusts distribute income to beneficiaries, the income “passes through” to the beneficiary’s tax return instead of the trust’s return. This requires consistent communication between the trustee and beneficiaries (or their accountants).

Inheritance and Estate Tax

While North Carolina does not impose an inheritance tax, federal estate tax laws may apply. Federal estate tax applies to the total value of the decedent’s estate, and this may include trust assets. Trustees should keep this in mind when making distributions, since beneficiaries could face tax implications depending on the trust’s value.

For instance, imagine a trust holding assets worth $15 million. If the grantor passes away, the trust’s assets become part of the grantor’s total estate value, which can trigger federal estate taxes if the combined value exceeds the federal estate tax exemption. As of 2023, the federal estate tax exemption stood at $12.92 million. In this case, $2.08 million of the estate value would be subject to federal estate tax, potentially resulting in hundreds of thousands of dollars in taxes that must be paid before beneficiaries receive their inheritances.

This tax impact can significantly reduce the amount beneficiaries receive, especially if the estate’s assets are not liquid and must be sold to cover tax obligations. A qualified estate planning attorney can help you make important decisions that will impact your heirs, and potentially avoid the federal estate tax altogether.

Plan Ahead with Bespoke Estate Law

Trust taxes in North Carolina can be complex, but with careful planning and expert guidance, you can set your estate and beneficiaries up for a smooth ride. We help clients in the Myrtle Beach, SC and Wilmington, NC areas with all aspects of trust creation and administration. We make certain that your trust is administered smoothly and accurately aligns with your intentions. Gain peace of mind with a more secure financial future with Bespoke Estate Law.