Understanding the Tax Differences Between Revocable and Irrevocable Trusts

Trusts are a powerful estate planning tool, but not all trusts are treated the same—especially when it comes to taxes. At Hoffman Law Offices, we often advise clients on the critical distinctions between revocable and irrevocable trusts and how these differences can affect both estate planning and tax exposure.

Revocable Trusts: Control, But No Tax Shelter

A revocable trust, often called a living trust, allows the grantor (the person creating the trust) to retain full control over the trust assets during their lifetime. They can amend, revoke, or dissolve the trust at any time.

Tax Impact: Because the grantor maintains control, the IRS and state taxing authorities treat the assets in a revocable trust as if they still belong to the grantor. That means:

• The trust’s income is reported on the grantor’s personal tax return.

• The assets are included in the grantor’s estate for federal and state estate tax purposes.

• There is no estate tax savings by simply placing assets into a revocable trust.

The primary benefit of a revocable trust lies in avoiding probate, not reducing taxes.

Irrevocable Trusts: Tax Benefits With a Trade-Off

In contrast, an irrevocable trust requires the grantor to give up control and ownership of the assets placed in the trust. Once created, the trust generally cannot be changed or revoked.

Tax Impact: If structured properly, an irrevocable trust can:

• Remove assets from the grantor’s taxable estate.

• Potentially avoid estate tax on appreciation of those assets.

• Shift income tax liability (in some cases) to beneficiaries or to the trust itself.

But these benefits only apply if the trust is fully divested—meaning the grantor retains no right to income, principal, or control over the trust or its assets.

In Summary:

• Revocable trusts offer flexibility but no tax advantages.

• Irrevocable trusts, if fully divested, may provide significant estate and gift tax savings—but come with a loss of control.

If you’re considering a trust as part of your estate plan, it’s essential to understand how it will affect your taxes and long-term goals. The attorneys at Hoffman Law Offices can help structure a plan that fits your unique situation.

Disclaimer: This post is for informational purposes only and does not constitute legal or tax advice.