Trusts in California: Tax Implications Explained for 2026

Introduction: Trusts in California and Their Tax Implications (2026 Guide)

Trusts are a powerful tool in estate planning, offering key benefits such as asset protection, probate avoidance, and greater control over how your wealth is distributed. Whether you're setting up a revocable or irrevocable trust, these legal structures can play a critical role in preserving and transferring assets efficiently.

However, trusts also come with important tax implications that must be carefully evaluated. In California, trusts may be subject to both federal and state taxes, including income tax, and potentially gift or estate taxes, depending on how the trust is structured. Without proper planning, these tax obligations can reduce the overall value of your estate and impact your beneficiaries.

Understanding how trusts are taxed at both the federal and California state levels in 2026 is essential for maximizing tax efficiency, staying compliant with evolving regulations, and avoiding costly mistakes. This guide will break down everything you need to know to make informed estate planning decisions.

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1. How Trusts Are Taxed in California

Trusts can be subject to both federal and state taxes, depending on their structure. The primary taxes that apply to trusts include:

• Income Tax: Trusts must pay income tax on any earnings generated by trust assets, including interest, dividends, and capital gains. Trust income is taxed at the federal level, and California also imposes a state income tax on trust earnings, often at higher rates due to compressed tax brackets.

• Estate Tax: The federal estate tax applies to estates exceeding the exemption threshold (expected to adjust from $13.61 million per individual in 2024, with potential changes in 2026). Although California does not impose a state estate tax, federal estate taxes may significantly impact high-value estates and certain types of trusts.

• Gift Tax: The federal gift tax applies to transfers of wealth made during your lifetime. While California does not have a state-level gift tax, federal gift tax rules still apply to transfers involving trusts, especially for irrevocable trust funding and wealth transfer strategies.

2. Types of Trusts and Their Tax Treatment

The tax implications of a trust largely depend on its type. There are two main categories of trusts, revocable trusts and irrevocable trusts, each with its own tax consequences.

Revocable Trusts (Living Trusts)

• Tax Treatment: Revocable trusts, often referred to as living trusts, offer flexibility during the grantor’s lifetime because they can be altered or revoked at any time. For tax purposes, the IRS and the state of California treat the assets in a revocable trust as if they are still owned by the grantor (the person who created the trust). This means that any income generated by the trust assets is reported on the grantor’s personal income tax return, and the trust itself does not file a separate tax return.

• Estate Tax: Since the assets in a revocable trust are still considered part of the grantor’s estate, they are subject to federal estate taxes if the estate exceeds the federal estate tax exemption limit. However, the trust can help avoid probate, which is a significant advantage in California’s often lengthy and expensive probate process.

Irrevocable Trusts

• Tax Treatment: Irrevocable trusts, unlike revocable trusts, generally cannot be modified or revoked once established (except in limited circumstances). For tax purposes, an irrevocable trust is treated as a separate legal entity.

  
  

  In 2026, the trust must file its own income tax return using Form 1041 and pay taxes on any income that is retained within the trust. This includes earnings such as interest, dividends, and capital gains.

  
  

  Trusts are subject to highly compressed federal tax brackets, meaning they can reach the highest federal income tax rate (currently around 37%, subject to IRS adjustments in 2026) at relatively low income levels. California also imposes state income tax on trust earnings, with rates reaching up to 13.3%, depending on the trust’s income and residency rules.

• Estate Tax: One of the primary advantages of irrevocable trusts is their ability to reduce estate tax liability. Assets transferred into an irrevocable trust are generally removed from the grantor’s taxable estate, making this a powerful estate planning strategy for high-net-worth individuals.

  
  

  However, transfers to an irrevocable trust may trigger federal gift tax if they exceed the annual exclusion limit (expected to adjust from $17,000 per recipient in 2024, with possible increases in 2026 due to inflation adjustments). Proper structuring is essential to maximize tax efficiency and compliance.

Grantor Trusts

A grantor trust is a type of irrevocable trust where the grantor retains certain powers over the trust, such as the ability to reclaim assets or control trust investments. For tax purposes, the income generated by a grantor trust is reported on the grantor’s personal tax return, even though the trust itself is irrevocable.

Non-Grantor Trusts

In a non-grantor trust, the grantor does not retain control over the trust assets, and the trust is treated as a separate taxpayer. Non-grantor trusts must file their own tax returns and pay taxes on undistributed income. However, any income distributed to beneficiaries is taxable to the beneficiaries, not the trust.

3. California State Income Tax for Trusts

In California, trusts are subject to state income tax based on the residency of the trustee and the beneficiaries, as well as where the trust assets are located. California has some of the highest income tax rates in the nation, which can significantly impact trusts with income-producing assets.

• Resident Trusts: A trust is considered a California resident trust if the trustee or beneficiaries reside in California. Resident trusts are subject to California state income tax on all income, regardless of where the assets are located or where the income is generated.

• Non-Resident Trusts: Trusts that do not have California resident trustees or beneficiaries are only subject to California state income tax on income derived from California-based sources, such as rental property located in the state.

Given California’s complex residency rules, trustees and beneficiaries should carefully evaluate the tax implications of where they reside and where trust assets are located.

4. Capital Gains Tax on Trusts

Trusts are also subject to capital gains tax on the sale of trust assets. If the trust holds an asset, such as stock or real estate, and later sells it for a profit, the trust must pay capital gains tax on the appreciated value. The federal capital gains tax rate varies based on the length of time the asset was held, with long-term capital gains generally taxed at a lower rate (20% maximum).

California does not distinguish between long-term and short-term capital gains; all capital gains are taxed as ordinary income, meaning they can be subject to rates as high as 13.3%. Trustees should consider the timing of asset sales to minimize capital gains tax exposure.

5. Strategies to Minimize Trust Tax Liabilities

While trusts can be subject to significant taxes, some strategies can help minimize tax liabilities and preserve more wealth for beneficiaries. Some of these strategies include:

• Distributing Income to Beneficiaries: Trusts that retain income are taxed at higher rates than individuals. One way to reduce trust taxes is to distribute income to beneficiaries, who are often in lower tax brackets. Distributed income is taxed to the beneficiaries at their personal tax rates, potentially lowering the overall tax burden.

• Charitable Trusts: Establishing a charitable remainder trust or a charitable lead trust can provide both estate tax and income tax benefits. These trusts allow for the transfer of assets to a charity, reducing the taxable value of your estate while providing income to beneficiaries during your lifetime or a designated period.

• Gifting Strategies: High-net-worth individuals can reduce the taxable value of their estate by making lifetime gifts to beneficiaries. By gifting assets to an irrevocable trust, you can remove those assets from your taxable estate while taking advantage of the federal gift tax exclusion.

• Grantor Retained Annuity Trusts (GRATs): A GRAT allows the grantor to transfer assets to beneficiaries at a reduced gift tax cost while retaining the right to receive an annuity from the trust for a specified period. This can be an effective strategy for transferring appreciating assets with minimal tax impact.

Conclusion

Understanding the tax implications of trusts in California is essential for anyone engaged in estate planning. Trusts offer many benefits, including avoiding probate, providing for beneficiaries, and protecting assets, but they also come with complex tax rules that can impact the value of the estate and distributions to beneficiaries.

By working with an experienced estate planning attorney or tax professional, you can create a trust structure that aligns with your goals while minimizing potential tax liabilities. Whether you’re setting up a revocable trust, an irrevocable trust, or exploring more advanced estate planning tools, careful tax planning is critical to ensuring that your trust is as effective and efficient as possible.

Contact Us for Legal Help

If you have questions about estate planning and estate taxes, a California probate, your responsibilities as a Trustee, or how to properly administer a California trust, contact the top-rated California trust and probate attorneys Moravec, Varga & Mooney – today to schedule a telephonic consultation. Have questions, call (626) 460-1763 or email LV@MoravecsLaw.com.

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