Legal Definitions - Simple trust

A Simple trust is a specific type of legal arrangement used to manage assets for the benefit of one or more individuals, distinguished by its straightforward rules for income distribution. To qualify as a simple trust under Internal Revenue Service (IRS) regulations, it must meet three key requirements:

• Mandatory Annual Income Distribution: The trust is legally obligated to distribute all of the income it earns from its assets (such as interest, dividends, or rental income) to its beneficiaries every single year.
• Principal Preservation: The trust is prohibited from distributing any portion of its original capital or principal (the core assets initially placed into the trust) to the beneficiaries. Only the income generated from these assets can be paid out.
• No Charitable Contributions: A simple trust cannot make any donations or contributions to charitable organizations.

Like other trusts, a simple trust is responsible for paying taxes on any income it earns, including capital gains, before distributing the net income to its beneficiaries. This structure is often chosen when the goal is to provide a consistent income stream to beneficiaries while ensuring the underlying assets remain intact for future use or distribution.

Examples of a Simple Trust in Action:

• Grandparent's College Living Expense Fund:

  A grandparent sets up a trust fund for their grandchild, placing a sum of money into it. The trust agreement specifies that all investment income generated by this fund each year must be paid directly to the grandchild to help cover living expenses while attending college. The principal amount of the trust, however, is to remain untouched and invested until the grandchild graduates or reaches a certain age, at which point the entire principal will be distributed. The trust explicitly states it cannot make any charitable donations.

  This is a simple trust because: All income is distributed annually to the grandchild, the original principal is preserved and not distributed during the income payout phase, and no charitable contributions are allowed.

• Rental Property Income for an Elderly Relative:

  A daughter places a rental property she owns into a trust for the benefit of her elderly mother. The trust document mandates that all net rental income collected from the property each year must be paid out to the mother to supplement her living expenses. The rental property itself (the principal asset) is to remain within the trust until the mother's passing, after which it will be transferred to the daughter's children. The trust agreement also forbids any charitable giving.

  This is a simple trust because: All net rental income is distributed yearly to the mother, the principal asset (the rental property) is not distributed during the mother's lifetime, and no charitable donations are permitted.

• Investment Portfolio for a Young Professional:

  A parent establishes a trust holding a diversified investment portfolio for their adult child who is starting their career. The trust agreement dictates that all dividends and interest earned from these investments must be distributed to the child annually, providing a steady supplemental income. The original investment capital, however, is to remain fully invested within the trust until the child reaches age 35, ensuring long-term growth and a substantial future payout. The trust document also explicitly prohibits any charitable contributions.

  This is a simple trust because: All income (dividends and interest) is distributed annually to the adult child, the principal (the original investment capital) is preserved and not distributed, and no charitable contributions are allowed from the trust.