Unlike irrevocable trusts, revocable trusts ordinarily offer no relief from estate taxation because the grantor maintains control over the assets he places into it. Whether you're acting as trustee for someone else's trust, or if you're doing your own estate planning, the value of the estate comes down to the worth of its assets less certain allowable deductions, and the assets must be included when you complete Form 706 – the Federal Estate Tax Return – for the Internal Revenue Service.
Your taxable estate – which is not necessarily the same as your probate estate – includes virtually everything you own and even anything you own a share of. If you jointly hold property with someone else, your percentage of ownership must be included on Form 706. Assets passing directly to named beneficiaries, such as life insurance proceeds or retirement accounts, must also be reported, even though they don't require probate to transfer ownership. Exceptions exist for assets that you or your revocable trust no longer have control over, such as a life insurance policy that you've transferred to someone else's ownership.
One of the challenges of Form 706 is establishing accurate values for your assets. The IRS doesn't allow you to take an educated guess, nor would you want to. If you're wrong and you guess high, you could end up costing your estate tax dollars. The IRS wants your property's fair market value – what someone would reasonably be willing to pay for the asset under normal economic circumstances when neither party is desperate to buy or sell. Value can be relatively easy to ascertain when you're dealing with stocks, bonds, or liquid accounts. For other assets, such as real estate, your trustee may have to arrange for appraisals. Value is typically established as of the date of your death, although the IRS allows certain variations.
Form 706 also allows your trustee to take certain deductions to subtract from the estate's value for tax purposes. Your estate only pays taxes on the portion of value that exceeds that year's estate tax exemption. The exemption can fluctuate from year to year depending on current tax law, but it's a dollar amount that your trust can transfer to beneficiaries tax-free. After valuing your assets and taking available deductions, Form 706 determines if your estate is worth more than this exemption amount, and the balance is subject to tax. Deductions include any assets transferred to your spouse – these are not taxable – as well as any debts existing at the time of your death that your estate must pay. They also include property your trust donates to charity and costs of settling your estate.
Capital Gains Factors
If your beneficiaries decide to sell the assets you've bequeathed to them, any profit they realize is subject to capital gains tax. The cost basis is the value of the property at the time of your death, however, not when you originally acquired it. For example, you may have purchased your home for $150,000 but it's worth $500,000 at the time of your death. If your trust distributes this asset to your daughter and she sells the property for $500,000, she owes no capital gains tax. She does not have to pay tax on the difference between $150,000 and its current value. If your trustee files Form 706, it establishes the cost basis for your daughter so she doesn't have to claim capital gains.