Financial planning includes periodically meeting with an experienced estate tax attorney to ensure that one’s estate plan is current and meets the objectives of the individual. When meeting with legal counsel, one would be well served by understanding the differences between a revocable trust and an irrevocable trust. All comments here are personal and should not be considered the rendering of legal advice. We are not attorneys. Only attorneys can render legal advice which is why we recommend that you seek competent legal advice on these matters.
In its most simplistic terms, a revocable trust (RT) is where the grantor of the trust (you) continue to own the assets in the trust. The trust is reported under your social security number and all income of the trust is reported by you. RTs are often referred to as “grantor trusts” or “living trusts” and are essentially just an extension of your will.
A RT differs from an irrevocable trust (IT) where the ownership of the assets is transferred to an IT which obtains its own employer identification number (EIN). The income reported by the IT is usually taxed either by the trust or to its beneficiaries if distributed to them. There are ways that an IT will be treated as a grantor trust such as when the grantor retains a 5 percent or larger reversionary interest in the trust property or the grantor retains any significant level of administrative control of the trust.
Here is a quick synopsis of the some of the features/benefits of each trust:
Asset Protection: RT has no asset protection. The grantor, the trustee, and the beneficiary are often the same person and the grantor never gave up ownership of the assets placed in the trust. One major benefit of an IT is that if you are sued and you made a legitimate transfer of your assets to an IT and the IT is managed by an independent trustee, the party suing you cannot take what you do not own. In other words, the assets within the IT are asset protected. You may also wish to add another layer of protection if creating an IT . . . by adding a “trust protector” to your trust.
Probate: Probate is eliminated for both the RT and the IT.
Estate Taxes: A RT’s assets are subject to estate and inheritance taxes because the owner still controls the assets in the trust. With respect to an IT, the assets are not subject to the estate tax because the deceased did not own the assets and the trust is considered a “living being”.
Defer Capital Gains on the Transfer of Assets: Since the owner of the assets continues to own the assets if a RT is used, all future capital gains will be taxed to the owner. However, any appreciation of assets that occurs after the transfer of assets to an IT will be deferred and taxed to the IT when disposed.
When assets are transferred from the owner’s name to an IT, depending upon the value of the assets transferred, tax planning is essential to avoid or minimize the gift tax on the transfer of the assets to the IT. As with most financial decisions, it is important to consult with experienced attorneys and tax professionals.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.