The Tax Implications for a Living Revocable Trust

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A trust is a legal document that establishes rules for how your assets are managed during and after your lifetime. If a trust is "living" and "revocable," then that means you've established the trust during your lifetime and you maintain the right to change or abolish it whenever you want. There are several advantages to creating a living revocable trust; in addition to avoiding probate after death, your beneficiaries may save on taxes as well.

Tax Implications

Living revocable trusts do not protect settlers or beneficiaries from federal income taxes, despite rumors to the contrary. The federal government taxes estates valued above $5 million, but not heirs. Assets that pass to named beneficiaries, such as life insurance proceeds or 401k distributions, are tax-free for the beneficiaries. According to, both wills and trusts offer the same level of tax protection with proper planning. Remember, however, that many states impose their own taxes on estates, and the exemption may be less than $5 million. Check with an estate planning attorney with regard to your state's rules.

Avoiding Probate

The biggest reason to establish a living revocable trust is the avoidance of probate. When a living revocable trust is funded with the settler's assets, they pass immediately to the trust's beneficiaries. A will must be approved as valid by a probate court, and assets that don't have named beneficiaries, such as real estate, jewelry or non-retirement investment account balances, are frozen until the will is approved. In addition to the amount of time it takes to go through probate, the expense may be considerable. In California, for example, will administrators may charge more than $10,000 to distribute the will's assets.

The Marital Exemption

A surviving spouse is entitled to special benefits, according to IRS rules. Married couples who anticipate leaving behind estates in excess of $5 million may elect to take advantage of the Unified Estate and Gift Tax Credit and the Credit Exemption Trust, which lets one spouse pass assets to the other, with the children as later-named beneficiaries, through an irrevocable "bypass" or AB trust. This plan lets assets pass to the surviving spouse tax-free.

The Portability Clause

Married couples who both pass in 2011 or 2012 can transfer up to $10 million in assets via the IRS "portability" rule, which eliminates the need to establish a bypass trust, according to the legal website Keep in mind that this right isn't automatically applied; the surviving spouse must file an estate tax return even if no tax is owed. After the portability clause expires, however, there may be a need for your family to establish an AB trust. Speaking with an estate planning attorney and tax adviser is your best bet if your assets exceed $5 million.