Irrevocable Living Trust

Can an Irrevocable Living Trust save you income, gift and death taxes? Absolutely!!

However, for most people, the "cure" is worse than the "illness" since you have to give away assets to achieve the tax benefits.

But, if you are wealthy enough to afford to give away assets, an irrevocable trust is a tool that can provide you and your estate significant tax savings.

To explain an irrevocable living trust, we should review the fundamentals of a revocable living trust.

The typical living trust is revocable. Because it is revocable, you (assuming it is your trust) still have control of it and it is deemed to be yours for tax purposes.

You can use the assets in the revocable living trust for whatever you want. Even though you have placed them in the trust, you still control them.

Naturally, then, you continue to pay income taxes on the earnings of the revocable living trust.

And, when you die, the assets in the trust will count against your estate tax exclusion. Your estate will pay estate taxes (and any other "death taxes") on assets (if any) above your exclusion amount.

An irrevocable living trust (sometimes incorrectly spelled "irrevocible living trust") is a different animal altogether. As its name suggests, an irrevocable living trust cannot be amended or revoked.

Essentially, when you place assets into an irrevocable living trust, you give them away for good. They are no longer yours.

The benefit of doing this is that you may reduce or avoid:

  • Tax on income from the trust; and,

  • Death taxes on assets in the trust.

In order to gain the benefits of reduced or eliminated income and death taxes, you have to ensure that you have no "incidents of ownership" in the trust. Specifically, the trust must have an independent trustee and specify that you cannot:

  • Control how the trust is administered;

  • Change the beneficiaries or amounts;

  • Obtain income from the trust; or,

  • Make personal use of assets in the trust.

For example, you might transfer assets to an irrevocable living trust for the benefit of your child. You are essentially giving your child a gift.

Of course, in the tax world, there is no such thing as a free lunch.

Income taxes will still be paid on income assets in the irrevocable living trust earns. The only difference is that, instead of you paying them, the trust will pay them. Hopefully, however, the trust will pay income tax at a lower rate than you do.

Death taxes (i.e. estate taxes) will potentially be replaced by a "gift tax" on assets placed in the irrevocable living trust.

However, there are ways to get around paying gift taxes.

Probably the best way to avoid paying gift taxes is by using your annual gift tax exclusion. That exclusion is currently set at $12,000.

So, you could place up to $12,000 (per person) into the irrevocable trust gift tax free. And, your spouse could do the same thing. Together, the two of you could put $24,000 into the irrevocable living trust for each beneficiary. And that's every year.

Even if you went over the $12,000 annual exclusion, you still could avoid gift tax by using your lifetime gift tax exclusion which is currently set at $1,000,000. [But, if you use part of your lifetime gift tax exclusion, you will reduce your estate tax exclusion. So, you get into complicated issues involving the interplay of the gift tax and estate tax exclusions. To determine what's best for you, you'll want to talk to an estate planning attorney.]

The bottom line is: if you have disposable assets you can afford to give away, an irrevocable living trust makes it possible to transfer assets to beneficiaries free of estate or gift taxes and also, possibly, save income taxes on income from the assets.

The one catch, however, is that, in order to qualify as a "completed gift," for purposes of using your annual gift tax exclusion, you have to actually give the beneficiary a "present interest" in the gift. In other words, the beneficiary has to be able to take the gift and spend it or otherwise use it for whatever he wants.

This is usually fine if your beneficiary is an adult. But, if he or she is a minor, you probably don’t want to give them $12,000 cash. Fortunately, there is a way to navigate the tax minefield and accomplish your goals. To find out how, see Crummey Trust.

Some refer to Irrevocable Trusts as Inheritors Trusts which you can read more about at What is an Inheritors Trust? If your interested in the tax advantages an Irrevocable Living Trust offers, you'll be surprised by how life insurance can be used to leverage much greater tax savings by use of an Irrevocable Life Insurance Trust.

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Simple and very easy to understand, also there was a wealth of information for me that really helped me decide whether to have a living trust or not.

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