What Are the Disadvantages of an Irrevocable Trust?

By David Carnes

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.

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.

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.

Protect your loved ones. Start My Estate Plan

Separate Taxation

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.

Gift Tax

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.

Protect your loved ones. Start My Estate Plan
Can an Irrevocable Trust Be a Grantor Trust?

References

Related articles

Tax Benefits of Irrevocable Trust

When you create a trust, you transfer your property and other assets into the care of a trustee. You can use a trust to transfer property to your heirs or to another person during your lifetime. A trust can also be used to shelter assets and income from creditors. An irrevocable trust, by definition, cannot be changed but carries some important tax advantages.

What Is a QPRT Trust and How Does It Work?

The QPRT, or Qualified Personal Residence Trust, is a legal tool which is designed to reduce estate or gift taxes on the transfer of a personal residence to family members. By transferring a personal residence into the trust, the owner may continue to use the residence while potentially reducing the tax burden on himself and his beneficiaries.

What if I Don't Issue a K-1 for a Distribution to Beneficiary of a Trust?

If you serve as the trustee of a trust, you have a number of reporting obligations under the federal income tax laws, which includes the preparation of Schedule K-1 for each beneficiary. In the event you fail to issue a K-1, you may find yourself paying a substantial amount of penalties to the IRS.

LegalZoom. Legal help is here. Start Here. Wills. Trusts. Attorney help.

Related articles

Trustee Not Paying Beneficiary

A trustee is a party who administers the assets of a trust and distributes them to beneficiaries in compliance with ...

Rights of the Beneficiary of a Family Trust

A family trust is a trust in which the beneficiaries are family relations of the grantor. Since the assets of a ...

Can I Pay Medical Expenses From an Irrevocable Trust?

A trust is a method of placing assets under the control of a trustee, for the purpose of passing these assets to ...

Responsibilities of a Living Trust Executor

The executor of a living trust, normally referred to as the trustee, holds legal title to all trust assets but is ...

Browse by category
Ready to Begin? GET STARTED