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Irrevocable Living Trusts
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Introduction
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An Irrevocable Living trust is an arrangement
in which the grantor departs with ownership and control of property usually during his
lifetime. The transfer is sometimes referred to as an inter vivos (Latin for during one's
lifetime) or a "living" trust. Usually this involves a gift of the property to
the trust. The trust then stands as a separate
taxable entity and pays tax on its accumulated income. Irrevocable Living trusts typically
receive a deduction for income that is distributed on a current basis. Because the grantor
must permanently depart with the ownership and control of the property being transferred
to a trust, such a device has limited appeal to most taxpayers. 
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Grantor Transfers
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A grantor's use of Irrevocable Living trusts to avoid taxation of
income, and to provide for accumulation of income to provide for beneficiaries at a later
date, has been limited under the current tax system. The Revenue Reconciliation Act (RRA)
of 1993 has made these trusts subject to faster tax rate escalation than
individual taxpayers. For example, Irrevocable Living trusts are taxed at 35 percent on
taxable income in excess of $10,000 (check). For filers of joint returns, the 35% percent
rate does not begin until taxable income is $300,000 (check.
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Adverse Income Tax
Consequences
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Ironically, the impact of RRA changes will not severely impact Irrevocable
Living trusts whose grantors or beneficiaries are already in the highest tax percent
bracket; they will affect the smaller estates of middle and upper-middle income taxpayers,
whose grantors and beneficiaries are in lower tax brackets. To avoid being taxed at the
higher rates, trust income can be reduced by increasing distributions
to beneficiaries, reducing the amount of taxable income produced by the trust assets, or having the trust invest in assets that produce capital gain (maximum tax
rate is only 28 percent) rather than ordinary income.
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Family Planning Opportunities
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Since an Irrevocable Living trust is taxed as a separate entity on accumulated income, it
is sometimes desirable to create as many trusts as possible for
purposes of accumulating income at the lower tax brackets. However, two or more
trusts will be treated as one trust if the trusts
have substantially the same grantor and primary beneficiaries, and federal tax avoidance
is the principal purpose of the trusts. Code §643(f).
Although limited in recent years, income splitting among family members through family
Irrevocable Living trust arrangements remains a valid way of reducing overall family
income tax. Although an assignment of income from one family member to another is not
sufficient, an outright transfer of income-producing property this trust can
achieve income splitting. If the family member to be benefited lacks the ability to manage
the assets, you can use a trust. If the beneficiary is a minor, you may
consider the creation of a custodial account under the applicable state's Gifts to Minors
Act or the Uniform Transfers to Minors Act instead of a trust.
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Conclusion
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The use of Irrevocable Living trusts in sophisticated tax planning involves a
multitude of complex tax rules. You should consult with a tax planning professional to
obtain the optimal tax results.
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[Wealth Preservation]
[Employee Stock Options]
[Foreign Taxpayers]
[Tax & Trust Scams]
[Expert Witness]
[General Tax Information]
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All contents copyright © 2008 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet(TM) is a trademark of Robert L. Sommers.
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