Pennsylvania Trust Taxation Guide
What Families, Trustees, and Beneficiaries Must Know About Inheritance Tax, Probate, Asset Titling, and Tax Basis After a Trust-maker’s Death
Many Pennsylvanians create revocable living trusts, irrevocable trusts, and other estate-planning structures to avoid probate, simplify administration, protect assets, or plan for long-term care. Unfortunately, misunderstandings about Pennsylvania law lead families—and even trustees—to make costly mistakes. Special needs and pooled trusts are a different type of trust altogether and not addressed here. The focus of this article is to shed light on the truth that Pennsylvania inheritance tax applies to trust assets more often than most people expect, and a poorly administered trust can cause:
- Avoidable taxes
- Probate that the grantor hoped to avoid
- Loss of asset protection
- Exposure to Medicaid or creditor recovery
- Errors in basis step-up calculations
- Confusion about who legally owns assets
- Disputes between beneficiaries
This guide explains when trust assets ARE taxable, when they are NOT, how trust funding affects taxation, and what trustees must do under Pennsylvania law.
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3. Revocable Trusts That Become Irrevocable at Death: Still Taxable
A common misunderstanding is: “When a revocable trust becomes irrevocable at death, the assets become non-taxable.” This is incorrect.
Pennsylvania inheritance tax is based on ownership at the moment of death. If the trust was revocable up until death, then all assets are taxable, even though the trust becomes irrevocable afterward.
4. “Funding Failures”: When the Grantor Forgot to Put Assets Into the Trust
This is one of the most common—and expensive—mistakes. Many grantors:
- Sign the trust
- Put the trust binder on a shelf
- Never retitle accounts or real estate
- Never transfer investment assets
- Forget to update beneficiary designations
The result:
- Some assets end up in the trust
- Other assets remain outside the trust and require probate
- Inheritance tax still applies to both sets of assets
- Estate administration becomes MORE complicated than if the grantor used a simple will
In many cases, probate becomes necessary precisely because the trust was not funded correctly.
5. Trustee Failures: The “Set It and Forget It” Problem
Under Pennsylvania law, trustees must:
- Follow the trust document
- Collect and safeguard trust assets
- Obtain valuations
- Keep records
- File tax returns
- Provide notice to beneficiaries
- Meet statutory fiduciary obligations
But in real life, many trustees—especially family members—do none of this. Typical failures:
- Trust books placed in a drawer for years
- Assets never retitled into the trust
- No accounting provided
- Real estate taxes unpaid because the trustee assumed the trust “ran itself”
- Trustees continue using joint accounts or personal funds
- No tax filings for the trust
These failures can:
- Expose trust assets to inheritance tax they might otherwise avoid
- Expose the trustee to personal liability
- Require probate because assets were improperly titled
- Result in surcharges or lawsuits between beneficiaries
Trust administration requires active management—not passive ownership.
6. Tax Basis Rules for Trust Assets
A crucial but often overlooked area is how assets in trusts receive their tax basis for federal capital gains purposes.
A. Revocable Trust Assets Receive a Full Step-Up in Basis
Because the grantor is treated as the owner, all assets in the trust at death get:
- Step-up to date-of-death value
- Large benefit for real estate and appreciated securities
- This is often good for beneficiaries.
B. Irrevocable Trust Assets MAY NOT Receive a Step-Up in Basis
If the gift was a completed gift, and the grantor retained no rights:
- Basis does not adjust at death
- Beneficiaries take the carryover basis
- This can create substantial capital gains tax upon sale
- This is why trying too hard to avoid probate can backfire.
C. Irrevocable Trusts With Retained Powers Often DO Receive a Step-Up
If the grantor retained enough powers or benefits, the trust assets may be included in the taxable estate and therefore receive a basis step-up.
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8. Tax Requirements During the Grantor’s Lifetime
Whether a trust is revocable or irrevocable, federal and state rules apply during the grantor’s life.
A. Revocable Trusts
- Report on the grantor’s personal tax return (disregarded entity)
- No separate trust return needed
- Income taxable to the grantor
B. Irrevocable Trusts
May require:
- Form 1041 for federal fiduciary income tax
- Pennsylvania income tax filings
- Crummey notices for gift-tax compliance
- Gift tax returns (Form 709) for transfers
- Documentation proving “completed gifts”
- Records for the one-year inheritance tax rule
- Noncompliance can cause the Department of Revenue to treat the trust as:
- Invalid
- Revocable in substance
- Fully taxable
Conclusion: Every Trust Must Be Evaluated Individually Under Pennsylvania Law
Trusts are powerful planning tools—but only when created, funded, and administered correctly. In Pennsylvania, trust assets often are subject to inheritance tax, and avoiding probate does not necessarily save tax or protect beneficiaries.
A Pennsylvania estate and trust attorney can:
- Determine which trust assets are taxable
- Review trust documents and funding
- Advise trustees on legal obligations
- Correct funding failures
- File inheritance tax returns
- Protect basis step-up opportunities
- Avoid unnecessary probate
- Prevent disputes among heirs
Call Us!
If you have questions about how a trust will be taxed, whether a trust was funded properly, or what a trustee must do under Pennsylvania law, contact our law firm.
We frequently handle trust administration, inheritance tax matters, and probate cases throughout:
- Schuylkill County, Pennsylvania
- Northumberland County, Pennsylvania
Call our office today for trusted guidance on any trust or estate matter.