When you establish an irrevocable trust, the assets that you place in it no longer legally belong to you. An irrevocable trust typically cannot be revoked or amended without a court order or the consent of all beneficiaries. In exchange for giving up control over trust assets, the Internal Revenue Service offers certain tax benefits that are unavailable to revocable trusts.
Since the Internal Revenue Service treats revocable and irrevocable trusts quite differently, make sure that the trust is actually irrevocable before you attempt to claim tax benefits. If it turns out to be revocable, you can always amend it to turn it into an irrevocable trust. The trust is irrevocable if the trust document states clearly that it is irrevocable. If it doesn't, then its revocability depends on state law — some states will presume that it is revocable, while others will presume that it is irrevocable.
An irrevocable trust is taxed as a legally independent entity and in much the same way as an individual taxpayer in terms of income tax rates and available deductions. Contributing income-earning property to an irrevocable trust means that the IRS will treat the resulting income as trust income, not your income. This could put you into a lower tax bracket even if the trust is taxed at the lowest income tax rate.
The estate tax is levied against the estate of a deceased taxpayer. Estate tax must be paid before any estate assets are distributed to heirs. The IRS taxes only the value of an estate that exceeds the estate tax exemption — $5,120,000 as of publication. Since the assets of an irrevocable trust are not subject to estate tax, if you anticipate that the value of your estate will exceed the estate tax exemption for the year of your death, placing assets into an irrevocable trust and naming your heirs as beneficiaries can eliminate this liability.
Irrevocable Life Insurance Trusts
One way that the value of your estate could exceed the estate tax exemption is through life insurance proceeds, because these proceeds are included in the value of your estate. Contributing your life insurance policy to an irrevocable trust, however, renders these proceeds exempt from estate tax. If you anticipate that you will become liable for estate tax based on your other assets, you can use an irrevocable life insurance trust to help your heirs pay estate taxes after you die.
- Internal Revenue Service: Instructions for Form 1041 and Schedules A, B, G, J, and K-1
- Bankrate.com: How a Trust Is Taxed
- Internal Revenue Service: Abusive Trust Tax Evasion Schemes
- Maryland State Bar Association: Uniform Trust Code
- Internal Revenue Service: Charitable Contributions
- Wells Fargo Advisors: Irrevocable Life Insurance Trusts
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