Taxes & the Advantages of Living Trusts

By Christine Funk, J.D.

Taxes & the Advantages of Living Trusts

By Christine Funk, J.D.

There are two types of living trusts, revocable and irrevocable. They serve different purposes, and they have different advantages. When it comes to taxes, most people do not see any advantages or disadvantages based on the type of living trust they choose. If someone is particularly wealthy, an irrevocable living trust does offer tax perks. The main advantages associated with creating living trusts have to do with avoiding probate court.

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Revocable Trusts

With a revocable living trust, a person transfers ownership of their assets to the trust. Property with deeds, such as the homestead, must have the deeds changed to reflect the new owner. For example, instead of listing "Matt Olson" as the owner of the property, the deed must read, "Matt Olson, trustee of the Olson living trust." Similarly, the grantor, or person creating the trust, must change the titles on banking documents, brokerage accounts, and the like to reflect the existence of the living trust and to put the property into the trust. If necessary, the grantor can move the property or other assets into and out of the trust while they are still alive, changing the titles accordingly.

Putting property into a revocable living trust is neither an advantage or a disadvantage when it comes to taxes. Any income generated from the property in the revocable living trust is still subject to taxes. Matt Olson, in our example, remains responsible for those taxes at the same rate as if he owned the property himself. When Matt Olson dies, if his estate is large enough, it will still be subject to estate taxes, just as if he had had a last will and testament in place of a trust.

However, having a revocable living trust will save Matt Olson's heirs the time and expense associated with probate court. Wills, as well as estates wherein the property owner dies without a will, must go through probate court. This process can take many months. It also comes with probate fees that can reach 6%. The advantage of a revocable living trust is that the beneficiaries of the trust see their inheritance sooner and with fewer costs. Additionally, while probate proceedings are public, the contents of a revocable living trust are not.

Irrevocable Trusts

As the name suggests, an irrevocable trust is one the creator cannot revoke. Instead, the property is turned over to a third party for management, with identified receivers of the property, as well as details regarding the property's distribution. The irrevocable trust may contain property for future generations to enjoy or to be provided to identified parties upon the death of the grantor. The terms and conditions of an irrevocable trust are largely up to the person creating the trust, but it is a good idea to talk to a trusts and estates attorney about the structure of an irrevocable trust.

There are a few tax advantages to an irrevocable trust if someone is very wealthy. By putting some of their funds into an irrevocable trust before they die, they necessarily reduce the amount of wealth they have. However, if the irrevocable trust includes taxable gifts, the IRS currently includes those (dating back to gifts made in the year 1977) when assessing the value of the estate. Estate taxes are only assessed to estates exceeding around $11 million, as of July 2018. Consequently, the majority of the population need not concern themselves with the possibility of estate taxes. If you think you might be subject to estate taxes, it is a good idea to speak with both a financial planner and an attorney well versed in trusts and estate planning.

For most people, the advantages of trusts do not involve tax savings. Instead, trusts provide a way to transfer property before or upon the death of a person, without the hassle, delay, cost, or public airing of personal business associated with probate.

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