Do Trusts Pay Taxes in Tennessee? Trust Tax Rules and Which Assets Belong in Your Trust

The trust tax question arrives in our Nashville office in three forms. The first is the Middle Tennessee family who has read enough about federal trust brackets to be afraid of them. The second is the out-of-state family that has heard Tennessee called a trust-friendly state and wants to know whether moving the trust here actually saves anything. The third is the Tennessee family that already has a trust and is trying to figure out what to put into it and what to leave on the beneficiary designation. Each of them is asking some version of the same question. Do trusts pay taxes in Tennessee. The honest answer is that the Tennessee answer is shorter and friendlier than the marketing makes it sound, and that the federal answer is where almost all of the real tax planning happens. This article is the walk through.

We are going to lay out what Tennessee actually taxes and what Tennessee actually does not, how the federal grantor trust rules work for a revocable living trust, how the compressed federal trust brackets work for an irrevocable trust, what the federal estate tax exemption looks like for 2026 after the One Big Beautiful Bill Act, the four types of trusts most Tennessee families consider, the assets that should not be placed in any trust, the assets that can be but probably shouldn't be, and the federal 5-and-5 rule that shows up in well-drafted Tennessee trusts. Tennessee statutes, Internal Revenue Code sections, federal regulations, and Tennessee Department of Revenue notices are cited so the substance can be verified by your own counsel.

Do trusts pay taxes in Tennessee?

Trusts almost never pay Tennessee state tax. Tennessee does not impose a state income tax on individuals or on trusts (the Hall income tax was fully repealed effective January 1, 2021 under Public Chapter 467 of 2016). Tennessee does not impose an inheritance tax (repealed for decedents dying on or after January 1, 2016 under Public Chapter 480 of 2012). Tennessee does not impose a separate estate tax. Tennessee trusts can owe federal income tax, federal estate tax, and federal capital gains tax depending on the trust structure and whether the grantor is still living. Tennessee may impose its franchise and excise tax on certain irrevocable trusts that hold a Tennessee business interest, with a safe harbor under Tenn. Code §67-4-2007 for grantor trusts and certain estates.

That paragraph is the answer to the search. The rest of the article is the substance behind it.

The Tennessee tax answer, in plain English

Tennessee is one of the most trust-friendly tax jurisdictions in the United States. The legal historians and the trust industry have a longer name for it (The Tennessee Trust Advantage), but the working tax facts are simple. A trust formed in Tennessee, administered by a Tennessee trustee, holding Tennessee-source income, does not owe Tennessee state income tax on that income. A Tennessee resident who dies leaving a trust to Tennessee beneficiaries does not owe a Tennessee inheritance tax on the transfer. A Tennessee estate does not owe a separate Tennessee estate tax. A Tennessee revocable living trust does not file a separate Tennessee return during the grantor's life, because the trust uses the grantor's social security number under the federal grantor trust rules.

The three other states that match this combination are a short list. Tennessee, Florida, Texas, and a handful of others have built deliberate trust regimes that compete for nonresident trust business. Tennessee added the directed trust statute, the domestic asset protection trust under the Tennessee Investment Services Act at Tenn. Code §35-16, the community property trust under Tenn. Code §35-17, the 360-year dynasty trust, and the non-judicial settlement agreement for modifying irrevocable trusts. The tax answer is the part nonresident families notice first. The structural flexibility is the part their attorneys notice next.

The Hall tax, in case you saw the older article

For most of the last century, Tennessee did impose a narrow state income tax called the Hall income tax, on dividends and interest. The Hall tax was phased out in stages beginning in 2016 and fully eliminated effective January 1, 2021 under Public Chapter 467 of 2016. If you are reading an older Tennessee trust article that mentions the Hall tax as a current obligation, it is out of date. The Tennessee Supreme Court and the United States Supreme Court both addressed nonresident trust applications of the Hall tax before its repeal (see the discussion of Kaestner Trust v. North Carolina Department of Revenue, 588 U.S. ___ (2019), which constrained state taxation of nondistributing trusts on due process grounds and indirectly influenced Tennessee policy). After 2021 the academic question of whether the Hall tax reached a particular trust is moot. The current answer is that Tennessee does not tax trust income at the state level, period.

The Tennessee franchise and excise tax footnote

The narrow exception to the Tennessee no-state-tax answer is the franchise and excise tax, which applies to certain entities doing business in Tennessee. Under Tenn. Code §67-4-2007 and the Tennessee Department of Revenue safe harbor notice on trusts and estates, most grantor trusts and most family trusts that simply hold passive investment assets are not subject to the franchise and excise tax. An irrevocable trust that owns a Tennessee business interest, however, may be subject to franchise and excise tax on the business activity. The safe harbor and the application are technical, and any Tennessee trust that holds a business interest should be reviewed with tax counsel before any franchise and excise filing decision. For most Tennessee families with a revocable trust holding the house, the brokerage account, and the cash reserves, the franchise and excise tax does not apply. For most Tennessee families with an irrevocable trust holding the same passive assets, the franchise and excise tax also does not apply. The exception is the trust holding the business.

How a revocable trust is taxed federally

A revocable living trust is the most common Tennessee trust by a wide margin, and it is the easiest to tax. During the grantor's life, the federal grantor trust rules at Internal Revenue Code §671 through §679 treat the trust as if it does not exist for income tax purposes. The grantor reports all trust income on the grantor's individual Form 1040. The trust uses the grantor's social security number. No separate trust return is filed. The trust is invisible to the IRS until the grantor's death.

The grantor trust rules in one paragraph

A grantor trust is any trust over which the grantor retains enough control or beneficial interest to be treated, for federal income tax purposes, as the owner of the trust assets. The classic example is the revocable living trust, where the grantor retains the power to revoke under §676. Other grantor trust triggers include the retained power to control beneficial enjoyment under §674, the retained reversionary interest under §673, certain administrative powers under §675, and certain economic benefits to the grantor or grantor's spouse under §677. The practical consequence is that the grantor pays the income tax on the trust's income at the grantor's individual federal rate, the trust does not file Form 1041, and the trust grows free of any second layer of income tax during the grantor's life.

What changes at the grantor's death

The grantor trust treatment ends at the grantor's death. The trust becomes a separate taxpayer for federal income tax purposes, gets its own federal employer identification number, and files Form 1041 each year until the trust is fully distributed. The assets held in the trust at the grantor's death receive a step-up in basis to fair market value under Internal Revenue Code §1014, because the trust is includible in the grantor's gross estate under Internal Revenue Code §2038 (the retained power to revoke). The step-up is the federal tax benefit Tennessee families notice most clearly, because it can save the family six figures of capital gains tax on appreciated Tennessee real estate or appreciated stock when the children later sell.

Why the revocable trust does not save federal estate tax

A revocable living trust does not reduce federal estate tax for the simple reason that the grantor retained the power to revoke. Under Internal Revenue Code §2038, any property over which the decedent retained a power to alter, amend, revoke, or terminate is includible in the gross estate at the decedent's death. The revocable trust is in the estate. The fact that the trust avoids probate has no effect on the federal estate tax calculation. Families that need to reduce federal estate tax exposure use irrevocable structures, not revocable trusts. For most Tennessee families, the federal estate tax exemption is large enough that no federal estate tax is owed on either path. For high-net-worth Tennessee families, the irrevocable side of the planning matters.

How an irrevocable trust is taxed federally

An irrevocable trust is harder to tax than a revocable trust, and the math is harsher unless the trust is drafted to push income out to beneficiaries. The default rule is that the trust is a separate taxpayer, files Form 1041, and pays federal income tax on accumulated income at the compressed trust tax brackets.

Compressed trust tax brackets, in working numbers

Federal trust income tax brackets hit the top rate much faster than individual brackets. For a recent filing year, an irrevocable trust pays the top 37% federal rate on accumulated ordinary income above approximately $15,200 for 2024 returns, indexed annually per IRS Rev. Proc.. By comparison, a married couple filing jointly does not hit the top 37% rate until taxable income exceeds approximately $750,000. The same dollar of accumulated trust income is taxed at the top rate at a tiny fraction of the income level a married couple would face. The drafting answer to the compressed brackets is to distribute income, not accumulate it.

Distributable net income, in plain English

Distributable net income, or DNI, is the federal mechanism that lets a trust push income out to beneficiaries and tax that income at the beneficiary's rate rather than at the trust's compressed-bracket rate. The trust takes a deduction for distributions up to DNI on Form 1041. The beneficiary receives a Schedule K-1 reporting the distributed income and reports the same income on the beneficiary's Form 1040. The result is that the income is taxed once, at the beneficiary's individual rate, rather than at the trust's compressed-bracket rate. For most irrevocable trusts with beneficiaries who are not in the top federal bracket, distributing the income each year saves meaningful tax.

Grantor trust irrevocable variations

A trust can be irrevocable for state law and gift tax purposes and still be a grantor trust for income tax purposes. This is the structure behind the intentionally defective grantor trust, the Medicaid Asset Protection Trust drafted under Internal Revenue Code §677, and certain irrevocable life insurance trusts. The grantor pays the trust's income tax on the grantor's own Form 1040, the trust grows free of any second income tax layer, and the trust assets sit outside the grantor's gross estate for federal estate tax purposes. The structure is the workhorse of high-end Tennessee trust planning, and it relies on the careful coordination of the grantor trust rules in §671 through §679 with the estate tax inclusion rules in §2036 through §2042. For the MAPT version of the structure, see our Medicaid Asset Protection Trust page.

Why Tennessee makes irrevocable trust planning especially attractive

The Tennessee no-state-income-tax answer matters most for irrevocable trusts that accumulate income. A non-grantor irrevocable trust formed in Tennessee, administered by a Tennessee trustee, holding non-Tennessee-source income, generally does not owe Tennessee state income tax on accumulated income (the federal income tax still applies). A similar trust formed in a high-tax state can owe 10 to 13 percent state income tax on the same accumulated income. Over a long trust term, the Tennessee state tax savings compound. This is the math that brings nonresident families to Tennessee for irrevocable trust planning.

Do trusts avoid inheritance tax?

In Tennessee the question answers itself. Tennessee has no inheritance tax. The Tennessee inheritance tax was phased out and fully eliminated for decedents dying on or after January 1, 2016 under Public Chapter 480 of 2012. No Tennessee trust owes a Tennessee inheritance tax because no Tennessee estate owes one. The trust does not change the answer because the answer is already zero.

That paragraph is the answer to the search. The rest of the substance is what families really want to know.

The federal estate tax, after the 2025 One Big Beautiful Bill Act

Federal estate tax is a separate question, and it is the part of the trust tax conversation that high-net-worth Tennessee families spend the most time on. The federal estate tax exemption was scheduled to sunset at the end of 2025 to the pre-Tax Cuts and Jobs Act level (approximately $5.5 million indexed). The One Big Beautiful Bill Act of 2025 (OBBBA) repealed the sunset and made a higher exemption permanent beginning in 2026. First Citizens Wealth and other industry sources report the 2026 federal estate tax exemption at $15 million per individual and $30 million per married couple under OBBBA; confirm the exact figure against current IRS Rev. Proc. before publication. For Tennessee families with estates below the exemption (which is most Tennessee families), the federal estate tax simply does not apply, and no estate tax return is filed on Form 706. For Tennessee families with estates above the exemption, the federal rate ranges from 18 to 40 percent on the excess.

Trusts that actually reduce federal estate tax

A revocable living trust does not reduce federal estate tax (see above). The trusts that do reduce federal estate tax are irrevocable structures designed to move assets out of the grantor's gross estate during life or at death. The most common Tennessee tools are these four.

The irrevocable life insurance trust, or ILIT, owns the policy from inception so the death benefit is not included in the grantor's gross estate under §2042. A well-drafted ILIT pays the premium each year through Crummey gifts from the grantor, with beneficiary withdrawal rights tracked carefully and the 5-and-5 rule used to prevent the lapse of those withdrawal rights from creating a separate gift tax issue.

The spousal lifetime access trust, or SLAT, is an irrevocable trust funded by one spouse for the benefit of the other spouse, removing the funded amount from the grantor's estate while preserving indirect access through the spouse-beneficiary. SLATs require careful drafting to avoid the reciprocal trust doctrine when both spouses fund SLATs for each other.

The grantor retained annuity trust, or GRAT, is an irrevocable trust under §2702 that pays the grantor an annuity for a term, with the remainder passing to beneficiaries free of additional gift tax if the trust assets outperform the IRS Section 7520 rate. GRATs reward grantors who fund them with high-growth assets.

The qualified personal residence trust, or QPRT, transfers a residence to an irrevocable trust with the grantor retaining the right to live in the home for a term, removing the residence from the grantor's estate at the end of the term if the grantor survives. The QPRT trades the step-up in basis at death for the gift tax savings during life, which is rarely the right trade for a Tennessee family with a long-held appreciated residence.

For most Tennessee families below the federal estate tax exemption, none of these structures is needed. For families above the exemption, the choice is fact-specific and worth a tax-counsel conversation.

The 4 types of trusts most Tennessee families consider

The PAA question "what are the 4 types of trusts" is asked by a lot of people for an oddly precise number. The honest answer is that trusts come in many flavors and the four most Tennessee families actually consider are these.

1. Revocable living trust

The flexible workhorse of Tennessee estate planning. The grantor retains the power to revoke or amend, serves as the initial trustee, and names a successor trustee to take over at incapacity or death. Used primarily for probate avoidance, incapacity planning, privacy, and control over the timing of distributions to beneficiaries. Does not protect assets from creditors and does not reduce federal estate tax. Files no separate return during the grantor's life. For the full treatment, see our Tennessee revocable living trust overview and our disadvantages of a revocable living trust article for the honest tradeoffs side.

2. Irrevocable trust

The fixed structure used when the grantor wants creditor protection, Medicaid planning protection, or removal of assets from the gross estate for federal estate tax purposes. The grantor relinquishes the power to revoke and typically cannot serve as trustee. Common Tennessee variations include the Medicaid Asset Protection Trust drafted under Tenn. Code §35-15 and Internal Revenue Code §677, the Tennessee Domestic Asset Protection Trust under Tenn. Code §35-16, and the irrevocable life insurance trust drafted to keep the death benefit outside the gross estate under §2042. See our asset protection trust and Medicaid Asset Protection Trust pages for the structural details.

3. Testamentary trust

A trust created inside a will that springs into being at the testator's death. The trust does not exist during the testator's life and the will controls until probate. Common Tennessee uses include trusts for minor children inside a will, trusts for a surviving spouse with remainder to children, and trusts for a beneficiary who needs management of the inheritance. Because the testamentary trust is created by the will, it does not avoid probate (the will runs through probate, and the trust takes shape on the other side of that process).

4. Special needs trust

A trust drafted to preserve a disabled beneficiary's eligibility for needs-based public benefits, including Medicaid and Supplemental Security Income. Federal rules at 42 USC §1396p(d)(4) authorize the first-party special needs trust funded with the beneficiary's own assets and the third-party special needs trust funded by family members. Tennessee uses both structures under Tenn. Code §35-15. The trust holds funds for supplemental needs (the items beyond what the public benefits cover), and distributions are made by the trustee, not handed to the beneficiary. For the full Tennessee treatment, see our special needs trust overview.

A note on Tennessee-specific structures

Two Tennessee structures sit alongside the four types and deserve specific mention.

The Tennessee Community Property Trust, drafted under Tenn. Code §35-17, lets a married couple convert separate property into community property by transferring it into the trust. At the first spouse's death, all of the property in the trust receives a full step-up in basis under Internal Revenue Code §1014, instead of the half-step-up the couple would receive in a non-community-property state. The federal capital gains tax savings for a Tennessee married couple with appreciated assets can be substantial. The trust requires a Tennessee trustee.

The Tennessee Domestic Asset Protection Trust, or DAPT (also called a Tennessee Investment Services Trust, or TIST), drafted under Tenn. Code §35-16, is a self-settled irrevocable trust that the grantor can fund while remaining a beneficiary, with the trust assets generally protected from the grantor's future commercial creditors after the running of the 18-month look-back period. The DAPT requires a Tennessee trustee who is not the grantor and who materially participates in the trust administration. It is the right tool for a Tennessee family with professional liability exposure, divorce risk, or business-creditor concerns.

The main purpose of having a trust

People ask "what is the main purpose of having a trust" expecting one answer. There is no single answer because a trust does several jobs and most families want some combination. The six legitimate jobs a properly drafted and funded trust does well are these.

Probate avoidance. A funded trust passes its assets to beneficiaries outside the probate process. For a Tennessee family with a home, this is the most common reason to use a trust. The trust avoids the 9-to-14-month uncontested probate timeline, several thousand dollars in court costs and attorney fees, and the public record of who got what.

Privacy. A Tennessee probate file is public. A trust transfer is not. For a family with public-figure beneficiaries, complicated family dynamics, or a discomfort with the courthouse record, the trust answers the privacy question.

Incapacity management. A funded trust paired with a durable financial power of attorney lets a successor trustee step in and manage the grantor's affairs without a Tennessee conservatorship. The successor trustee can pay the bills, manage the investments, sell the home if needed, and otherwise act as the grantor would have acted.

Control over how and when beneficiaries receive. A trust can hold assets for a beneficiary until the beneficiary reaches a chosen age, complete a degree, or meet other conditions the family considers important. A trust can also hold assets for the lifetime of a beneficiary with remainder to the next generation, which is the standard dynasty structure.

Asset protection (irrevocable structures only). A properly drafted irrevocable trust, including a Tennessee DAPT, can shield assets from the grantor's future creditors. A revocable trust does not provide this protection, because the grantor retained the power to revoke (see our disadvantages of a revocable living trust discussion).

Tax planning at the federal level. An irrevocable trust drafted to move assets out of the gross estate can reduce federal estate tax exposure for high-net-worth families. The state-tax savings are usually a side benefit of the federal-tax structure, because Tennessee imposes no state income tax on the trust to begin with.

What assets cannot be placed in a trust

Most assets can be placed in a Tennessee trust. A small list cannot be placed in a trust at all, and a longer list can be placed in a trust but should not be. This section answers the literal question. The next section answers the practical one.

Retirement accounts (IRA, 401(k), 403(b), Roth IRA)

Traditional IRAs, 401(k) accounts, 403(b) accounts, and Roth IRAs cannot be retitled into a trust during the grantor's life without triggering full taxation as a distribution. The Internal Revenue Code treats any transfer of a retirement account out of the participant's name as a complete withdrawal, with the entire account balance taxed as ordinary income in the year of the transfer and a 10 percent early withdrawal penalty added if the participant is under 59½. The correct planning move is not to transfer the retirement account into the trust during life, but to coordinate the beneficiary designation on the retirement account with the trust at death. The trust can be named as the beneficiary if the trust qualifies as a designated beneficiary under the SECURE Act ten-year payout rule (Pub. L. 116-94, Division O), or the spouse or adult children can be named directly as the beneficiaries. The right answer depends on the family's tax situation and the kind of trust drafted.

Health savings accounts and medical savings accounts

HSAs and MSAs carry the same problem as retirement accounts. Transferring an HSA or MSA into a trust during life triggers immediate taxation of the account balance as ordinary income and eliminates the tax-free treatment of qualified medical expenses. The correct planning move is to name beneficiaries directly on the HSA. The same rule applies to MSAs.

Vehicles

Vehicles can technically be retitled into a Tennessee trust through the Tennessee Department of Revenue, but the administrative cost is rarely worth it for a typical family vehicle. Tennessee does not currently offer a transfer-on-death vehicle registration that bypasses probate for a vehicle, but the value of a personal vehicle is usually low enough that the small-estate path under Tenn. Code §30-4-103 (currently a $50,000 personal property threshold) covers the transfer. For a high-value collector vehicle, retitling into the trust may be worth the effort. For the daily driver, it usually is not.

Life insurance policies, except in an ILIT

A life insurance policy can be retitled into a revocable trust during life. For most families, the better answer is to keep the policy ownership in the insured's name and name the trust (or specific individuals) as the beneficiary. Transferring ownership into an ILIT (irrevocable life insurance trust) removes the death benefit from the gross estate under §2042 but requires the insured to survive three years from the transfer to complete the removal. The ILIT is a deliberate federal-estate-tax planning move, not a routine funding step.

Foreign assets

Real estate and financial accounts held outside the United States carry their own legal regimes, and Tennessee trusts often cannot hold those assets cleanly. A separate trust under the law of the country where the asset sits is usually the right answer. The coordination of a Tennessee trust with a foreign trust requires international tax counsel and is well outside the scope of this article.

Active checking accounts

A primary checking account used for daily bills can be retitled into the trust, but the practical friction often outweighs the benefit. Most banks let the account holder name a payable-on-death beneficiary, which passes the account outside probate with no trust funding required. The trust answer is technically correct for the checking account, and the POD answer is usually easier on the family.

UTMA and UGMA accounts

A custodial account under the Uniform Transfers to Minors Act or the Uniform Gifts to Minors Act is irrevocable in a different sense. The funds belong to the minor once the account is funded, and the custodian holds them until the minor reaches the age of majority (18 or 21 in Tennessee, depending on how the account was set up). The custodian cannot move the funds into a trust without violating the UTMA/UGMA rules. The correct planning move for new gifts to a minor is to use a trust from the start instead of a UTMA account.

Social security benefits

Federal law prohibits the assignment of Social Security benefits to a trust. The benefits must be paid directly to the recipient or to an authorized representative payee. A trust provision that tries to direct Social Security benefits into the trust is unenforceable and should not be drafted.

What you shouldn't put in a trust (even when you can)

A second list of assets can be placed in a trust but usually should not be. These are the practical mistakes we walk our Tennessee clients past.

Your primary checking account, in most cases

See above. The friction of running daily bills through a trust account with the trustee's title on every check, every debit card, and every online banking transaction is usually not worth the small probate-avoidance benefit. A payable-on-death designation on the checking account does the same work with less friction.

The car you drive every day

Title transfers at the Tennessee Department of Revenue for a daily-driver vehicle add cost without adding meaningful benefit. The small-estate affidavit under Tenn. Code §30-4-103 covers the vehicle if the personal property total is under $50,000 per Tenn. Code §30-4-103. For collector vehicles, racing vehicles, or other high-value assets, the trust is the right answer. For the family car, leave it where it is.

Business interests with transfer restrictions

A Tennessee LLC operating agreement, a partnership agreement, or a corporate shareholder agreement may forbid transfer of the membership interest, partnership interest, or share to a trust. Putting the business interest into the trust without amending the underlying agreement can violate the agreement and create a default. The right answer is to amend the underlying agreement first, then transfer the business interest into the trust under the amended terms.

Property in a state with hostile trust law

A few states still apply unfavorable rules to revocable trusts holding in-state real estate. For Tennessee families with property in those states, the cleaner answer is often a separate state-specific trust drafted under the law of the state where the property sits, with the Tennessee trust handling the Tennessee assets. The deed work is the same, and the state-specific trust avoids a series of administrative headaches that the cross-state Tennessee trust would otherwise carry.

Personal property of low value but high emotional weight

Family heirlooms, jewelry, art with sentimental rather than financial value, and similar items can be left out of the trust and addressed by a separate letter of intent, sometimes called a personal property memorandum. Tennessee allows a written memorandum incorporated by reference into the will or trust to direct specific items of personal property to named individuals. The memorandum is easier to update than the trust and keeps the trust document free of the long list of specific gifts.

What the 5-of-5,000 rule actually means

The PAA question "what is the 5 of 5000 rule in trust" is one of the more technical searches in this cluster, and it deserves a careful answer. The 5-of-5,000 rule, more commonly called the 5-and-5 rule, is a federal tax rule under Internal Revenue Code §2041(b)(2) and §2514(e). It is not a Tennessee rule.

The 5-and-5 rule lets a trust beneficiary withdraw, each year, the greater of $5,000 or 5 percent of the trust principal, without the lapse of that withdrawal right triggering federal gift or estate tax consequences for the beneficiary. The mechanism solves a specific federal-tax-law problem. When a trust gives a beneficiary the power to withdraw trust principal, the lapse of that power at year-end is technically a release of a general power of appointment under §2041 and §2514, which can be treated as a taxable gift from the beneficiary back to the remainder beneficiaries. The 5-and-5 rule is a safe harbor that exempts the lapse from gift and estate tax treatment up to the greater of $5,000 or 5 percent each year.

Tennessee trust drafters use the 5-and-5 power in two common situations. The first is the irrevocable life insurance trust (ILIT) with Crummey withdrawal rights on annual premium contributions, where the lapse of the withdrawal right at the end of each year must stay within the 5-and-5 safe harbor to avoid the gift tax problem on the lapse. The second is certain marital trusts and credit shelter trusts, where the surviving spouse has limited withdrawal rights coordinated with the federal estate tax exemption. In both cases the 5-and-5 rule is a drafting tool the attorney handles silently. The beneficiary rarely needs to know the federal section numbers. The family needs to know the rule exists and is reflected correctly in the trust the family signed.

Frequently asked questions about Tennessee trust taxes

Do trusts pay taxes in Tennessee? Trusts almost never pay Tennessee state tax. Tennessee does not impose a state income tax (the Hall income tax was fully repealed effective January 1, 2021), does not impose an inheritance tax (repealed effective January 1, 2016), and does not impose a separate estate tax. Tennessee trusts can owe federal income tax, federal estate tax, and federal capital gains tax depending on the trust structure and whether the grantor is still living.

Do trusts avoid inheritance tax? In Tennessee, the question is moot. Tennessee has no inheritance tax. A few other states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) still impose an inheritance tax, and a trust funded with property in those states can sometimes reduce the inheritance tax exposure. For Tennessee families, no inheritance tax planning is required because no inheritance tax is owed.

Does Tennessee have state income tax for trusts? No. Tennessee does not impose a state income tax on individuals or on trusts. The Hall income tax was fully repealed effective January 1, 2021 under Public Chapter 467 of 2016. A Tennessee trust, administered by a Tennessee trustee, holding any source of income, does not owe Tennessee state income tax on that income. The federal income tax still applies under the rules described above.

What are the benefits of a trust in Tennessee? Probate avoidance, privacy, incapacity management, control over how and when beneficiaries receive, asset protection (in irrevocable structures only), and federal tax planning. The Tennessee no-state-income-tax answer is a structural advantage that compounds over a long trust term, which is why nonresident families set up trusts in Tennessee.

Which trusts are not taxed? Every trust is taxed under federal law somewhere. A revocable trust during the grantor's life is taxed on the grantor's individual Form 1040 under the grantor trust rules (§671 through §679), with no separate trust return filed. An irrevocable grantor trust is taxed the same way, with the grantor paying the income tax on the grantor's Form 1040. An irrevocable non-grantor trust files Form 1041 and pays federal income tax at the compressed trust brackets on accumulated income, or distributes the income to beneficiaries who then report it on their own returns. The combination most Tennessee families want, which is no Tennessee state tax plus federal grantor trust treatment, is a revocable living trust or an irrevocable grantor trust drafted with Tennessee situs.

What assets cannot be placed in a trust? Retirement accounts (IRAs, 401(k)s, 403(b)s, Roth IRAs) cannot be retitled into a trust during life without full taxation as a distribution. HSAs and MSAs carry the same rule. Social Security benefits cannot be assigned to a trust by federal law. UTMA/UGMA custodial accounts cannot be transferred into a trust because the funds belong to the minor. Foreign assets generally need a separate trust under the law of the country where they sit. Most other assets can be retitled into a Tennessee trust.

What shouldn't you put in a trust? The daily-driver vehicle (use the small-estate affidavit), the primary checking account (use payable-on-death), business interests with transfer restrictions (amend the underlying agreement first), property in a hostile-trust-law state (use a separate state-specific trust), and personal property of low financial value (use a personal property memorandum).

What are the 4 types of trusts? Revocable living trust, irrevocable trust, testamentary trust, and special needs trust. Tennessee also offers the community property trust under Tenn. Code §35-17 and the Tennessee Domestic Asset Protection Trust under Tenn. Code §35-16, which sit alongside the four basic types.

What is the 5 of 5000 rule in trust? The 5-and-5 rule under Internal Revenue Code §2041(b)(2) and §2514(e) lets a trust beneficiary withdraw the greater of $5,000 or 5 percent of trust principal each year without the lapse of that withdrawal right triggering federal gift or estate tax consequences for the beneficiary. It is a federal tax rule, not a Tennessee rule. Tennessee trust drafters use it most often in ILITs with Crummey withdrawal rights and in certain marital trusts.

What is the main purpose of having a trust? Probate avoidance for most Tennessee families. Privacy, incapacity management, and control over distributions are usually next. Asset protection and federal estate tax reduction require irrevocable structures and are reasons for a smaller subset of families. The Tennessee no-state-income-tax answer is a structural advantage but rarely the primary reason a Tennessee family creates a trust.

Does putting my house in a trust trigger Tennessee transfer tax? For most transfers to a revocable trust where the grantor is also the trustee, no. For the full deed-and-recording answer, see our house in a trust in Tennessee walk-through.

Does a trust protect my home from TennCare? A revocable trust does not. A properly drafted Medicaid Asset Protection Trust, funded more than 60 months before the TennCare CHOICES application, does. For the look-back math, see our TennCare 5-year look-back article.

What is the seven-year rule for trusts? The seven-year rule is United Kingdom inheritance tax law (Inheritance Tax Act 1984) and has no analogue in United States federal estate or gift tax law. The closest United States rule is the five-year look-back applied by Tennessee Medicaid for long-term care eligibility. A Tennessee family searching the term has almost certainly stumbled across UK content that does not apply.

Why the Tennessee trust tax question rewards a fifteen-minute conversation

The Tennessee answer to the trust tax question is structurally simple, and the federal answer is structurally complicated. For most Tennessee families with a revocable living trust, the working answer is that the trust pays no Tennessee state tax during the grantor's life, files no separate return during the grantor's life, and uses the grantor's social security number for federal reporting. For a smaller set of Tennessee families with irrevocable trusts, federal grantor trust treatment, compressed trust brackets, DNI deductions, and the 5-and-5 rule all matter. For a still smaller set of Tennessee families with estates above the federal estate tax exemption, ILITs, SLATs, GRATs, and QPRTs become the conversation. The fifteen-minute version of the conversation in our office usually puts the family in the right tier. Bring the trust agreement if you have one, the rough net worth picture, the location of the major assets, and the names of the beneficiaries. We walk through the Tennessee answer first, then the federal answer, then the funding decisions for the trust the family already has or the trust we are about to draft.

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