Tax Benefits of Irrevocable Trust

By Tom Streissguth

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.

Basic Terms

The grantor of the trust sets the basic terms of the trust, including a designation of the trustee and instructions on how the assets will be handled within the trust and/or conveyed to the beneficiary. In a revocable trust, the person who establishes the trust may alter its terms and maintain access to the assets. In an irrevocable trust, the terms of the trust cannot be changed by the direction of the grantor, trustee or beneficiary. A trust must file IRS Form 1041 in each year in which it earns at least $600 in income. Grantor trusts — in which the creator of the trust keeps control of the assets — are not required to file Form 1041, as the income is taxable to the grantor who declares the income on his own Form 1040.

Estate and Gift Taxes

In the eyes of the IRS, an irrevocable trust includes property that no longer belongs to you, and so the assets will not be subject to estate tax after your death. Although a revocable trust can help your estate avoid probate court, it does not shelter assets from the estate tax. The IRS does allow you to transfer as a gift to another person (or trust) as much as $13,000 each year, as of publication ($26,000 if you are married, filing a joint return) without incurring gift tax.

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Income Taxes and Life Insurance

In addition, transferring assets to an irrevocable trust can save on annual income taxes. The grantor of the trust is not personally liable for income taxes on trust income; the tax liability belongs to the trust itself. The variation in income tax brackets also allows you to move assets to a trust that enjoys a lower tax rate. If the irrevocable trust includes a life insurance policy, then the benefits paid to your beneficiaries after your death are not subject to federal income or estate taxes.

Charitable Donations

With an irrevocable trust, you can also designate a charity to receive either income or a portion of the principal amount that you place into the trust. The IRS rules allow you to avoid capital-gains tax on any donated money, and in some forms of trusts to deduct interest earned by the trust and donated to the charity. Assets donated to the trust do not count as part of your estate; you may also change the charity which receives the assets.

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