Taxation of a Revocable Trust

by Sean Butner
Estate planners often use revocable trusts for property transfers without passing through probate.

Trusts exist as separate legal entities from the people who create them. Often used to safeguard what happens to possessions and money after the creator dies, trusts can be established as revocable or irrevocable. Revocable trusts reserve the creator’s right to make changes, revoke the trust and access the trust assets as the trust creator sees fit. Because tax law bases its treatment of income-producing assets on who has the rights of ownership, revocable trusts often have little tax impact while the creator is alive.

During the Creator's Life

Trusts are distinct legal entities and because the creator of a revocable trust retains all the rights of ownership to any assets put into the trust, tax law treats any earnings from the trust as income to the creator. No separate forms are necessary. Instead, the creator passes any earnings or taxable events through to her own tax return.

After the Creator's Death

Once the creator of a trust passes away, the distinction of revocable or irrevocable loses its meaning. Instead, whoever takes over as the successor trustee is responsible for obtaining a taxpayer identification number and filing on behalf of the trust. While the trust is open, it is liable for the tax on any income earned by trust assets. Although many revocable trusts dissolve shortly after their creator’s death, some are intended to provide longer-range benefits than simply facilitating asset transfers to avoid probate.

Estate Tax Implications

The federal government and several states impose a tax on the value of a deceased taxpayer’s property, often referred to as a death tax. The taxable base for estate taxes is calculated by totaling up the fair market value of the person’s property at the day of death, subtracting certain deductions and exempt transfers and adding back in certain gifts made in anticipation of death. Because the creator of a revocable trust retains the rights of ownership, any assets in revocable trusts are part of the taxable estate.

Gift Tax Implications

Tax law defines a gift as giving up something valuable without receiving something valuable in exchange. Gifts above the exclusion amount -- set at $14,000 for 2013 -- adjusted annually and that aren’t otherwise exempt from gift taxes will incur a tax payable by the person making the gift. To make a gift to a trust, however, the creator would need to relinquish all rights of ownership over the asset. Transferring to a revocable trust doesn’t forfeit the giver's right to the property, so no gift occurs.

About the Author

Sean Butner has been writing news articles, blog entries and feature pieces since 2005. His articles have appeared on the cover of "The Richland Sandstorm" and "The Palimpsest Files." He is completing graduate coursework in accounting through Texas A&M University-Commerce. He currently advises families on their insurance and financial planning needs.

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