If you’ve heard any talk about the benefits of revocable trusts, chances are that you’ve run across claims about supposed tax benefits that these trust vehicles can offer. Given the increasing popularity of living trusts, it would certainly be a great selling point if those tax advantages were real. Estate planners across the United States could probably double their workload in no time at all just by aggressively advertising revocable trust taxes. After all, who doesn’t want to reduce their tax obligations? There’s only one problem with that idea: it’s simply not true.
In fact, your revocable trust won’t provide you any tax advantages. You cannot use a revocable trust to avoid estate taxes, reduce your gift taxes, opt out of inheritance taxes, or escape any portion of your income tax obligation. Despite that fact, there are many unscrupulous people who will try to sell you on the idea of revocable trusts by pointing to fictitious tax advantages that will never actually materialize. Since that probably contradicts things that you’ve read or heard in the past, let’s examine the relationship between your revocable trust and the issue of taxation to gain some additional insight into why things work the way they do.
Why Some Trusts Do Offer Tax Benefits
Many people might wonder why some trusts do offer tax advantages if the revocable trust cannot do the same. The answer is simple, of course. Yes, there is a type of trust that can reduce your income taxes and estate tax liabilities. It’s called the irrevocable trust, and it’s used by many Americans for those and other specific reasons. However, it is important to understand the basic reason why these two types of trusts are treated differently for tax purposes. It all comes down to ownership and control, and how the government views the assets within any given trust.
With the irrevocable trust, the assets within the trust are no longer owned by you or subject to your control. When you fund such a trust, the assets become the property of that trust and cannot be accessed by you. Moreover, the irrevocable nature of such a trust makes it all but impossible for you to either modify the trust or revoke it – and that means that you cannot come back five years later and regain ownership of the assets by dissolving the trust. And since the government views that assets as truly being beyond your reach, it cannot count them as part of your estate.
Any income that the trust earns is similarly separate from your personal income. As a result, the trust assets and income won’t be counted for your personal income tax, estate tax, or most other tax purposes. Instead, the trust has its own tax identification number and reports its own income each year.
Why the Revocable Trust Does Not Offer Tax Benefits
The situation with your revocable trust is dramatically different. While it might seem that trust assets are beyond your control, nothing could be further from the truth. The reality is that the revocable nature of the trust provides you with an ongoing opportunity to revoke that trust at any time – and that would enable you to reclaim title to those assets. The government knows this too, and so it treats those assets and any income generated by them as your property.
More than that, though, these tax interpretations are written into the law. The Internal Revenue Code declares that trust assets are viewed as being owned by the person who created the trust, since that trust can be revoked and those assets can be reclaimed. That also means that the income generated by the assets in the trust is considered the grantor’s income, and must be included in his or her income tax returns.
As you might expect, the law also addresses the estate tax implications of a revocable trust. Here too the law specifically defines trust assets as part of the grantor’s estate in any instance where the trust can be revoked. That means that your revocable trust assets will be included as part of your estate when the IRS calculates any potential estate tax liability. Once again, the revocable trust provides no protection from estate taxes.
So why Use a Revocable Trust at All?
None of that means that revocable trusts are useless, of course. They still provide an excellent way to enjoy many of the benefits of sound estate planning. With these trusts, you can avoid probate, ensure that your heirs receive the full value of their inheritance, keep your estate settlement private, and even maintain control of your assets while you’re still alive. Used in conjunction with other estate planning tools, the revocable trust can help to ensure that you have everything you need for a sound estate strategy.
If you want tax advantages, of course, you’ll have to look at other options. In most cases, irrevocable trusts will be the better option for dealing with such tax concerns, since you can use them to reduce your taxable income, mitigate estate tax liability, and escape some capital gains taxes. Of course, the irrevocable trust can also be a tremendous asset for things like Medicaid planning as well – another area of planning where income and asset reduction can often make all the difference in the world.
Get the Help You Need
Revocable trusts are powerful estate planning tools that can help you to create a more organized and effective legacy to leave behind when your life ends. While they are not able to provide the tax benefits that some people claim, they do offer a whole host of other advantages that cannot be ignored. At the Fouts Law Group, LLC, our experienced trusts attorneys can answer any questions you may have about revocable trust taxes and help you determine which trusts and other tools will best meet your complex estate planning needs. To find out more about how we can help you to develop the best strategy for your legacy planning, contact us online or give us a call at (404) 596-7520.
