Can the IRS Levy Taxes From a Revocable Trust?

By David Carnes

Under a trust arrangement, a grantor funds the trust with assets and transfers these assets to a trustee, who holds them for the benefit of one or more beneficiaries. Trust assets are distributed to beneficiaries under terms established in the trust document. A trust is revocable if the grantor can change or terminate it at any time during his lifetime. If you owe overdue federal taxes, creating a revocable trust cannot protect you from the IRS.

Pass-Through Taxation Status

A revocable trust is subject to “pass through” taxation status because the IRS does not consider a revocable trust to be an independent taxable entity. This means that, for tax purposes, the IRS will ignore the revocable trust. Instead, the IRS will tax you on all trust income, and the IRS will consider trust assets to be your property. The reasoning behind this taxation status is that since you retain the power to revoke the trust, you have not really parted with your ownership rights, and thus the trust is not independent of you.

Revocability

The revocability of a trust depends on state law and the trust document that creates the trust. The trust document spells out the basic terms of the trust, and a well-drafted document will state specifically whether the trust is revocable or irrevocable. If the trust document is silent on the issue of revocability, its status depends on state law. As of 2013, in the 25 states that have enacted the Uniform Trust Code, a trust is revocable unless the trust document specifically states it is irrevocable. In addition, Section 676 of the Internal Revenue Code specifically defines revocability for purposes of federal taxation.

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Levy

Since the IRS considers the assets of a revocable trust to be your property, for tax purposes, the IRS and other creditors can reach these assets to satisfy your debts. As with any taxpayer, the IRS will assess taxes against you before they come due, to give you time to pay. If your tax liability becomes overdue, however, the IRS may eventually levy against your assets, including assets held in a revocable trust. A levy is a physical or legal seizure of your property to satisfy a tax debt.

Execution of a Levy

The IRS must send at least two notices before executing a levy – a Notice and Demand for Payment and, if your delinquency continues, a Final Notice of Intent to Levy and Notice of Your Right to a Hearing. It may send notices to the trustee to levy on any of your property held in a revocable trust. The IRS can place a levy on any type of property. The IRS may physically seize a movable asset, such as jewelry or an automobile, remove your name from a real estate title deed or seize funds from your bank account. The IRS is entitled to order a third party, such as the bank holding the trust account, to comply with its demands.

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How to Break an Irrevocable Trust

Two types of trusts are possible: a revocable trust and an irrevocable trust. Although the grantor can unilaterally revoke a revocable trust, even a revocable trust becomes irrevocable when the grantor dies. The assets of an irrevocable trust belong to the trust beneficiaries, not the grantor. Even an irrevocable trust can be revoked under certain circumstances, although it is almost impossible for a creditor of the grantor or a beneficiary to revoke it. Although the trust laws of the various states differ on the grounds and procedures for revocation, they are all based on similar principles.

How to Terminate Blind Trusts

A blind trust is a special type of trust where the beneficiaries are unaware of the trust's assets and a designated trustee has full authority to manage the trust, including the purchase, sale and exchange of its assets. Politicians and corporate officers often set up blind trusts to avoid conflicts of interest and public scrutiny. In some states, it is legal for a lottery winner to set up a blind trust so that he can anonymously claim his winnings. A trust creator, called the settlor, can set up his blind trust as either a revocable or irrevocable trust. If the blind trust is set up as a revocable trust, the settlor can terminate the trust by following the revocation procedure set forth in either the trust agreement or state statutes. While revoking an irrevocable trust is not always impossible, the process is difficult as it usually requires court approval and consent of all the trust beneficiaries. Common reasons a settlor may want to terminate his blind trust include a change in financial circumstances, unhappiness with the trust’s beneficiaries or desire to shelter trust assets from tax authorities.

Tax Treatment of Living Trust Distributions

When a grantor transfers assets to a trust during his lifetime, rather than having the trust take effect at death by operation of a will, the IRS treats it as a living trust. The tax treatment of distributions from any trust to its beneficiaries is the same, regardless of whether the trust is effective before or after the grantor’s death. The factors that determine who is responsible for paying the taxes on trust income depends on the stipulations of the trust document and whether the grantor retains the right to revoke it.

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