When a person undertakes estate planning, one of the many tools he can use is the revocable trust. This device is popular because it keeps the trust assets out of probate, which allows the beneficiaries to receive assets quickly after a decedent’s death. While the implications of a revocable trust to the probate estate is clear, the effect of the trust on the calculation of the gross estate for tax purposes can be ambiguous.
Revocable Trust Defined
A revocable trust is a device that a person creates while he is alive. Creating a trust requires the grantor to surrender ownership of property to the trust. The grantor donates this property in order to benefit select individuals, known as beneficiaries. The assets are managed by a trustee subject to conditions defined by the grantor, which are recorded in the trust agreement. In addition to identifying the beneficiaries and trustees, the trust agreement defines the circumstances when a trust’s property may be distributed and how the property should be maintained. A revocable trust allows the grantor to unilaterally change the terms of the trust and withdraw property from the trust at any time.
The federal estate tax is a levy on the distribution of a decedent’s assets. Only those assets that the decedent owned and controlled at the time of his death are taxable. These assets are included in the gross estate. To form a trust, the grantor must transfer his ownership in the trust property to the trustee. As a result, it would appear that the trust property would not be included in the gross estate. However, since the decedent retains the ability to regain the assets in a revocable trust, the property he donated to the trust is included in his estate. These assets are included in the estate under what is known as “the general rule of inclusion.” Only gross estates that are valued over $5.12 million are required to file federal estate taxes.
Exceptions to Rule of Inclusion
For property to be included in the gross estate, the decedent had to have had the ability to retake the assets unencumbered. On the other hand, if the grantor could regain the assets from the trust only under certain circumstances -- such as to pay his medical bills -- the assets are not included in his gross estate. In addition, if the grantor can withdraw trust assets only with the permission of someone who would be adversely affected by the withdrawal of the property -- such as a beneficiary -- the trust property would not be included in the gross estate. While the presence of any of these limitations on a grantor’s ability to withdraw the assets would probably mean the trust is not revocable, it is important to be aware of these limitations.
The gross estate is only the beginning of determining an estate’s tax liability. Once the gross estate has been calculated, deductions and credits are applied so that the taxable estate is often much smaller than the gross estate. Common deductions include property that was transferred to a spouse or charitable organization and balances for outstanding expenses that the estate is required to pay.