An estate or trust is a type of tax entity. Estates are entities that report income after an individual person has died and created by an act of their Will. If the person, for example, earns interest, dividends, or capital gains after his or her death, then that income is considered income for his or her estate, and the income must be reported on Form 1041, U.S. Income Tax Return for Estates and Trusts. Estates may also have to pay tax on the total value of assets if the estate is valued at more than $1,500,000. A tax on the value of the estate is reported on Form 706, U.S. Estate Tax Return. The estate tax is a tax on assets, whereas the estate income tax is a tax on income.
A trust is a type of tax entity. A trust is created by an individual person to protect or to preserve the person's assets, and to distribute income to beneficiaries. A trust may take effect during the person's life, or might take effect upon the person's death. A trust is managed by a trustee. The trustee is responsible for all aspects of the trust. The trust is a separate entity for tax purposes from the person who created the trust. The trust reports its own income and tax on Form 1041. The trust also reports income distributed to beneficiaries using Form K-1.
Setting up a trust is a legitimate way to manage your assets, especially when you want to control how your assets are managed after your death. You can set up a trust to accomplish any number of goals-such as providing income for your children, grandchildren, or other family members, for providing income for your favorite charities, or to distribute your assets to the exact people you want to.
Some people however get involved in abusive trusts, and the IRS is actively investigating the use of trusts to hide income. You cannot use trusts to hide income, and if you do, chances are the IRS will eventually catch up with you. If someone offers to set up a trust to reduce income or hide assets, and it sounds too good to be true, it might be an abusive trust. The IRS has warned people to be careful about trusts that sound too good to be true.