A revocable trust, which is an estate planning tool primarily used to help avoid probate, raises several different tax implications. The tax implications occur at the federal, or IRS, level, and also at the state level. The tax implications relate to both the grantor, meaning the person who created the trust, and the beneficiaries, meaning the person or people who receive distributions from the trust.
The IRS refers to a revocable trust as a grantor trust. The purpose of this nomination is to clarify that the IRS considers a revocable trust to be merely an extension of the grantor. In other words, any property owned by the trust or income produced by the trust is still the property and income of the grantor. The IRS does not consider a grantor trust to be a separate taxing entity. This is different from an irrevocable trust, which the IRS generally does treat as a separate taxpaying entity.
The trustee of a revocable trust is the person or company charged with the duty of administering and managing the trust. While the trustee of an irrevocable trust may have to file an annual tax return with the IRS on behalf of the trust, the trustee of a revocable trust does not have to file a tax return on behalf of the trust. Instead, the grantor of the revocable trust simply includes all trust income as the grantor's personal income.
The end result of a revocable trust is the trustee will eventually distribute the trust property to one or more beneficiaries. When that happens, each beneficiary will need to determine whether she needs to file an inheritance tax return with the state in which she resides. Some states impose an inheritance tax, while others do not. The obligation to pay inheritance taxes is the obligation of each beneficiary, not the grantor or trustee.
A revocable trust may raise federal estate tax implications. The federal estate tax is an assessment against the value of an estate in excess of $5 million as of publication. Accordingly, if a grantor dies at a time when the grantor's revocable trust has a total value of more than $5 million, then the trustee will need to file an estate tax return with the IRS. The trustee will pay the estate taxes directly from the trust property before distributing any of that property to the trust beneficiaries.
The Constitution Guru has worked as a writer and editor for "BYU Law Review" and "BYU Journal of Public Law." He is an experienced attorney with a law degree and a B.A. degree in history with an emphasis on U.S. Constitutional history, both earned at Brigham Young University.