Beyond the one-time estate tax on transfer at death, an estate and a trust are also taxpayers on the income they earn. The income of an estate under judicial settlement (during the period of administration or settlement) is taxed to the estate as a separate taxpayer, generally in the same manner and using the same rules and rates as an individual. Similarly, the income of a trust is taxed either to the trust as a separate taxpayer, or to the beneficiaries or grantor, depending on the type of trust (for example, income of a revocable trust or income for the benefit of the grantor is taxed to the grantor). A key feature is the deduction for distributions: in computing the taxable income of the estate or trust, the amount of income that is properly paid or credited to a beneficiary during the year is deducted at the estate/trust level and instead taxed to the beneficiary, avoiding double taxation of the same income. So the estate or trust is taxed on income it retains, while distributed income is taxed to the recipient. Consolidation rules also prevent splitting income among multiple trusts to reduce tax.
The estate tax is a one-time tax on the transfer at death. But while an estate is being settled, or while property is held in a trust, the income it earns is also taxed. Estates and trusts are taxpayers.
Two Different Taxes
Do not confuse:
- The estate tax — a one-time tax on the transfer of property at death; and
- The income tax on estates and trusts — a tax on the income earned by the estate during settlement, or by a trust.
Income of an Estate Under Settlement
The income of an estate under judicial settlement (during the period of administration or settlement) is taxed to the estate as a separate taxpayer, generally in the same manner and using the same rules and rates as an individual. So if the estate's properties generate rent, interest, or business income while being settled, the estate files and pays income tax on it.
Income of a Trust
The income of a trust is taxed either:
- To the trust as a separate taxpayer; or
- To the beneficiaries or the grantor, depending on the type of trust.
For example, income of a revocable trust, or income held or accumulated for the benefit of the grantor, is generally taxed to the grantor — preventing the use of trusts to escape tax.
The Deduction for Distributions
A key mechanism avoids double taxation: in computing the taxable income of the estate or trust, the amount of income properly paid or credited to a beneficiary during the year is deducted at the estate/trust level and instead taxed to the beneficiary. So:
- Retained income → taxed to the estate/trust; while
- Distributed income → taxed to the beneficiary.
The same income is not taxed twice.
Anti-Splitting (Consolidation) Rule
To prevent taxpayers from splitting income among multiple trusts to take advantage of lower brackets, the law provides consolidation rules — where several trusts are created by the same grantor for the same beneficiary, their incomes may be consolidated and taxed as one.
Practical Takeaways
- Beyond the one-time estate tax, an estate under settlement and a trust are taxed on the income they earn, like an individual;
- Income distributed to a beneficiary is deducted at the estate/trust level and taxed to the beneficiary, avoiding double taxation;
- Consolidation rules prevent splitting income among multiple trusts to reduce tax.
Frequently Asked Questions
Is an estate taxed on income while it is being settled? Yes. The income of an estate under judicial settlement, during the period of administration, is taxed to the estate as a separate taxpayer, generally in the same manner and rates as an individual. This is separate from the one-time estate tax.
How is the income of a trust taxed? Either to the trust as a separate taxpayer, or to the beneficiaries or grantor depending on the type of trust. For example, income of a revocable trust or income for the grantor's benefit is generally taxed to the grantor.
What is the deduction for distributions? In computing the estate or trust's taxable income, income properly paid or credited to a beneficiary during the year is deducted at the estate/trust level and taxed to the beneficiary instead, so the same income is not taxed twice.
Can trusts be used to split income and lower taxes? The law discourages it. Where several trusts are created by the same grantor for the same beneficiary, consolidation rules may combine their incomes and tax them as one, preventing income splitting to reach lower brackets.
This commentary is for general informational purposes only and does not constitute legal advice. For guidance specific to your situation, please consult a licensed attorney.
If you have questions about your rights or options under Philippine law, our firm is available to assist. You may reach us via Viber or WhatsApp, call us at 0995 433 5550, or send an email to vivasnobles@gmail.com. We look forward to hearing from you.