What Is the Tax Basis of a Revocable Trust?

What Is the Tax Basis of a Revocable Trust?
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A revocable trust -- a type of grantor trust -- is a trust in which the owner keeps control of the assets. Some people believe that revocable trusts can enable income tax avoidance. This is a misconception because the IRS requires the owner of the trust to pay taxes on any income earned from assets in the trust.

Revocable Trust Definition

A revocable trust shifts assets from your own legal ownership to that of the trust. The trust grantor may revoke or terminate the trust at any time. When a grantor creates a revocable trust, the ownership titles of the assets change to reflect ownership by the trust. The grantor may change the trustee, change beneficiaries, change the termination date and revoke the trust at any time.

Assets Held in Revocable Trusts

Common assets that you may place in a revocable living trust include real estate deeds, bonds, stocks, life insurance policies, retirement plan benefits, securities and bank accounts. If a revocable trust holds more than one asset, the grantor must initiate a transaction for each separate asset. The same distinctions between taxable and tax-exempt income apply to individual income and income in a revocable trust.

Federal and State Income Tax

Because the IRS classifies revocable trusts as grantor trusts, grantors are not required to file income tax Form 1041. Instead, a grantor must report all income and expenses on Form 1040, U.S. Individual Income Tax Return. The grantor pays income tax for the assets in the revocable trust each year when filing the income tax return. Follow individual state income tax guidelines to report trust income on state income tax forms.

Estate Taxes

Federal and state law requires that property assets in a revocable living trust become a part of the grantor’s estate at death. For 2011, only estates valued at more than $1 million and transferred to someone other than a charity or a spouse are subject to federal estate tax. State estate taxes vary. Visit your state revenue office's website to learn how your state levies estate taxes.