What Is a Irrevocable Living Trust?

Trust and estate law is an important field that helps people organize their assets so as to maximize their legacy. Probate avoidance is the most common reason for creating a trust. This can be achieved through a simple revocable living trust. An irrevocable trust, though organized under state laws, is subject to strict scrutiny by the Internal Revenue Service (IRS). To create real tax benefits, the creator of an irrevocable trust has to permanently give away certain assets and give up the right to change or cancel the terms of the trust without the permission of the beneficiary.

Identification

A living trust is simply one that is in effect during the lifetime of the person who creates the trust, called the grantor, as opposed to testamentary trusts that form upon the grantor's death. Most living trusts are revocable, meaning they can be changed or canceled, because the grantor might change his mind or need the assets of the trust for other purposes during his life. An irrevocable living trust is relatively rare because once it is created the grantor cannot easily change or cancel it.

Significance

Assets transferred to an irrevocable trust are essentially no longer the property of the grantor. This is true only to a lesser extent for revocable trusts. The IRS, for example, taxes any income or capital gains of a revocable trust as if it were earned by the grantor individually. Similarly, the assets of a revocable trust are counted toward the grantor's gross estate after death. Some, but not all, irrevocable trusts can avoid individual taxation or inclusion in the gross estate.

Function

In fact, tax avoidance is the primary reason for creating an irrevocable trust. Unlike revocable trusts, which can be used by virtually anyone, irrevocable trusts are usually a good idea only for wealthy individuals whose assets include property they can reasonably expect to never need during their own lifetime. In order to avoid individual and estate taxation, the grantor generally must totally surrender use and enjoyment of the trust assets as well as the ability to designate beneficiaries.

Effects

Though the grantor surrenders possession and control of the trust property, it doesn't necessarily mean the property goes to waste. The trustee will most likely be a close adviser who can assure the trust property is well managed for the beneficiaries. The assets most commonly held in irrevocable trust are life insurance policies, which the grantor usually would not be able to collect anyway. When the grantor dies, the trust continues without passing through probate or being subject to the estate tax.

Considerations

An important consideration with an irrevocable trust is whether the trust assets generate income. If the trust is in fact taxed as a separate entity by the IRS, it will be at a higher rate than for most individuals. Thus, income earned by the trust is often disbursed annually to beneficiaries to limit loss to taxes. This is usually important if the trust contains income-bearing assets like real estate or intellectual property.

References

• Gross Estate
• Irrevocable Living Trust
• Irrevocable Trust

Resources

• What Does Irrevocable Trust Mean?
• What is an Irrevocable Trust?
• Basic Trust Law