Many people new to estate planning associate trusts with the uber wealthy and believe that trusts must serve as a tax safe haven. That’s not true of revocable living trusts.
One of the two most common estate planning tools, revocable living trusts are a good fit for more than just the top 1% of wealthy Americans. The primary advantages of revocable living trusts compared to last wills are that they avoid probate, maintain privacy, offer greater control over gift distributions, and avoid guardianship if you become unable to manage your own affairs. Revocable living trusts do not, however, avoid taxes.
What is the tax treatment of revocable living trusts?
Tax treatment for property held in a revocable living trust is the same as if you held it directly, because the IRS considers the power to modify or cancel a revocable living trust as grounds that it continues to be owned by the Settlor (you) (I.R.C. § 676(a)). This means that you’ll report any income or capital gains on trust assets directly on your individual or joint tax return in the same manner that you do today.
Although you can implement advanced tax mitigation strategies alongside a revocable living trust to reduce or eliminate estate taxes, the revocable living trust itself does not convey any special tax savings.
Do other trusts avoid taxes?
A properly drafted and implemented irrevocable trust can avoid estate taxes. Irrevocable trusts differ from revocable trusts in that after you create and fund the irrevocable trust, you no longer have the ability to modify or cancel the trust, and you no longer own or control the trust property. Therefore, the trust property is not included in your estate for purposes of calculating estate tax.
Most people do not need to worry about paying estate taxes since the federal estate tax threshold is so high ($12.06 million in 2022). If you are among the few who do and considering creating an irrevocable trust to avoid estate taxes, you should engage an estate planning attorney for 1:1 legal advice specific to your particular situation.
Your estate planning attorney can help make sure that you fully understand your irrevocable trust and how to properly fund and maintain it. Irrevocable trusts are permanent – there’s no way to change one once it’s executed and funded. Additionally, transfers to irrevocable trusts are usually subject to gift tax, and while there are ways around paying the gift tax, you should work with your attorney to set up a plan that’s right for you.
Are revocable living trusts worth it?
Even though they don’t deliver estate tax savings, revocable living trusts can be well worth the cost to set up and maintain if you value the advantages of a revocable living trust over a last will. Additionally, the ability to modify or cancel revocable living trusts make them flexible estate planning vehicles that can adjust to your changing life and needs.
You can learn more here about revocable living trusts. When you’re ready to make your own, you can create your Just In Case Estates revocable living trust for a fraction of the cost of preparing one with an attorney. We’ll even help guide you in funding the trust.