Tax Consequences of an Inheritance From an Irrevocable Trust

by Debbie Donner ; Updated April 19, 2017
Retain no authority on the management of assets in your irrevocable trust.

A trust is a legal arrangement, in which control over property is held by a trustee on behalf of a third party, known as a beneficiary. An irrevocable trust cannot be altered or revoked, and assets placed into the trust cannot be removed. Generally, there are no tax consequences of an inheritance from an irrevocable trust. Irrevocable trusts offer tax advantages that a revocable trust does not, and stronger asset protection as well.

Irrevocable Living Trust

Although some people consider an irrevocable living trust too rigid and inflexible, many others are finding it may be the most effective way to protect their assets. In contrast, a revocable living trust generally does not offer the same protection, but it can be altered or revoked at any time, and you maintain complete control over the assets placed into the trust. When you create an irrevocable trust, you are known as the grantor or settlor. You are the one who funds or transfers assets into the trust, such as real estate, stocks, bonds or other property. You delineate how the fund assets will be managed and distributed to one or more beneficiaries. As the grantor, you will also choose one or more trustees to manage the trust. In some states, you can be both grantor and trustee.

Protecting Assets

Whether revocable or irrevocable, a living (intervivos) trust is created and funded while you are living. A revocable trust becomes irrevocable upon your death. To protect your assets from creditors for your future beneficiaries, it is necessary to have an irrevocable intervivos (living) trust. With adequate protective provisions, the assets can also be protected against your beneficiaries’ creditors. The primary drawback for many people is the loss of ownership and control over assets once they have been transferred to the trust. The assets become the property of the trust. Any assets not funded into the trust remain vulnerable to creditors and lawsuits. An irrevocable trust also lessens possible tax liabilities for those who will benefit from the assets in your trust.

Inheritance Tax vs. Estate Tax

When contemplating the tax consequences of an inheritance from an irrevocable trust, it is helpful to understand the difference between inheritance tax and estate tax. In some states, inheritance taxes are imposed on beneficiaries of an estate but are only assessed on the inherited portion. Estate tax is imposed on all residents and citizens of the U.S. by the federal government and is based on the entire estate’s fair market value. Estate tax is assessed prior to distribution of assets to the beneficiaries. An irrevocable trust prevents the assets in your estate from being taxed after your death.

Gift Tax

When you convey property to an irrevocable living trust, there may be gift tax consequences, because the transfer is considered a taxable gift. The transfer will not be subject to federal gift tax if the value of the asset transferred is less than the annual allowable exclusion for gifts. The annual exclusion amount as of publication is $13,000 per recipient. The gift must also be of a present interest, which means the beneficiary of the gift must hold the present right to the enjoyment and use of the asset.

About the Author

Based in California, Debbie Donner is a freelance online writer who primarily writes articles related to personal finance. Donner received a Mensa scholarship in 2006 while attending California State University, Fresno. She holds a Bachelor of Arts degree in liberal arts and a multiple-subject teaching credential.

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