A trust is a legal device that permits a grantor to place assets under the control of a trustee, then who administers the assets for the benefit of beneficiaries named by the grantor. A living trust is a trust created while the grantor is still alive -- as opposed to a testamentary trust, which is created by the terms of the grantor's will. A trust is irrevocable if the grantor cannot unilaterally revoke it.
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Loss of Control
Once the grantor establishes an irrevocable trust, he loses legal ownership of trust property -- the trustee holds it on behalf of the trust beneficiaries. No state allows a grantor to unilaterally revoke an irrevocable trust. In most states, an irrevocable trust can be revoked only by court order based on established legal grounds, or the consent of all trust beneficiaries. This loss of control over trust assets does not occur with a revocable trust.
An irrevocable trust, unlike a revocable trust, is a separately taxable entity. If the trust earns at least $600 in income during the tax year, the trustee must file federal income taxes every year and pay taxes out of trust assets. An irrevocable trust must file Form 1041 with the IRS, and must prepare Schedule K-1 for each beneficiary who received a distribution from the trust during the tax year. The trustee does not have to file Schedule K-1 with the IRS, but must distribute a copy to each beneficiary. Some state governments also tax trust income.
Gifts to a trust are subject to IRS gift tax. As of the date of publication, a gift tax exemption of $13,000 per year per beneficiary applies -- any amounts above that are subject to gift tax. The grantor, not the trust, pays the gift tax. Gift tax rates can be as high as 35 percent; however, they interact with the federal estate tax exclusion in complex ways that sometimes allow the grantor to avoid paying gift tax even on gifts that exceed the annual gift tax exclusion.
Income Tax Rates
Trusts pay federal income tax at rates that are generally higher than individual income tax rates. As of the date of publication, the maximum federal trust income tax rate is $2,937 plus 35 percent of any taxable income over $11,350. This rate applies to trusts with taxable incomes of over $11,350. Many trusts distribute assets to beneficiaries in amounts designed to put the trust into a lower tax bracket.
References & Resources
- Residual-Rewards.com: Irrevocable Living Trust Advantages and Disadvantages
- Ann Arbor Real Estate Group: What Are the Disadvantages of Irrevocable Trust?
- Whitmore Law Office: FAQs -- Living Trusts
- The Mamola Law Firm: Irrevocable Trusts
- Morton Law Firm, PLLC: Taxation of Trusts Simplified
- IRS.gov: Frequently Asked Questions on Gift Taxes
- Stockbyte/Stockbyte/Getty Images