A question I get frequently from estate planning clients, more out curiosity than anything, is what is the difference between revocable and irrevocable trusts? I say its out of curiosity mainly because the question comes from clients who have already read my book Estate Planning Basics, they have already decided on using a revocable living trust for their plans, but then they simply want to know if irrevocable trusts are an option for them. I thought it would be good to have a breakdown of three of these trusts based on purpose, use, and taxation.
The Revocable Living Trust
Purpose: Avoiding probate upon death and during incapacity.
Use: For estate planning only, although there are some lawsuit and other protective provisions for beneficiaries… but not for the people setting up the trust.
Taxation: Zero difference for income and capital gains taxes, but a couple can effectively double up their estate tax exemptions through the use of “credit shelter trusts.”
The Irrevocable Property Trust
Purpose: For the protection of highly appreciated assets in the Medicaid and Care Assistance Planning process.
Use: Real estate and possibly other highly appreciated assets are held in the trust under a separate trustee, but the clients get to live on any property, keep any income generated from it, but keep the responsibility for taxes and upkeep. Even with those benefits, the real estate is not “owned” enough for Medicaid to include the property on an applicant’s balance sheet(after five years).
Taxation: Income taxes are the responsibility of the clients, and the property is subject to estate taxes. However, if the client(s)’s estate is less than $11.83 million, then there are no estate taxes anyway. But the fact that the property is included in the estate calculations means that if the property is sold shortly after death, there should be no capital gains taxes.
The Irrevocable Family Trust
Purpose: For the protection of assets, mainly financial accounts, in the Medicaid and Care Assistance Planning process.
Use: Assets are held in the trust under a separate trustee, and the clients have zero right to the assets or income. However, these trusts are created with a close family member or friend as trustee who is able to “filter” money back to the clients if needed. Because those assets are not reachable by the clients, all of the assets are off the Medicaid applicant’s balance sheet (after five years).
Taxation: Income taxes are attributed to the Trust (on a 1041 trust tax return) or to the trustee (on their 1040), but taxes are not, and can’t be, the responsibility of the clients. The property is also not subject to estate taxes, but the fact that the property is not included in the estate calculations means that there would be capital gains taxes on the assets once sold.
These are the main highlights, and they represent the trusts we use in our office with our clients. The kinds of trusts that other attorneys use may be slightly or greatly different. For more details on these comparisons, check out the video by clicking here.