Using the Irrevocable Trust to Remove Assets from a Taxable Estate

A trust document, such as an irrevocable trust, is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries. A trust document is a private document and is not recorded or registered with the state, unlike a corporation or an LLC (limited liability document). Trusts come in two forms: revocable (able to be changed) or irrevocable (not able to be changed). Trusts are mainly used in estate planning but their benefits can also overlap with a business planning and/or estate tax reduction.

There are significant advantages to creating a trust. Specifically, a grantor can stipulate the terms of the trust document in order to have control over their wealth, even after death. A grantor can describe to whom they want their assets to be distributed to as well as the timing for such distributions. Some trusts allow for income and/or principal distributions to the grantor and their family during lifetime. A properly drafted trust can protect the estate from creditors of the heirs’ or from other beneficiaries who may not be capable of handling their inheritances (such as younger children). Also, since trusts are private documents, they uphold the privacy of families. Further, assets properly funded into trusts pass outside of probate. Finally, irrevocable trusts can be utilized (with very specific provisions) to remove assets from a grantor’s estate where their probate estate is taxable (over 5.45 million or double for marriage individuals).

Generally, for an irrevocable trust to be excluded from a grantor’s estate, the trust should be drafted where the trustee has the full discretion whether to pay income and/or principal to the grantor and there is no agreement that the grantor is entitled to any such distributions. Further, it is important to look at the laws in each particular state to determine whether creditors can reach the assets of the irrevocable trust. If creditors can pierce this trust “veil”, then the irrevocable trust may be subject to inclusion in the grantor’s taxable estate. If not, and pending the trust was drafted with the proper formalities, then the irrevocable trust will be excluded. For example, when drafted properly, irrevocable life insurance trusts are great vehicles to use to keep life insurance proceeds outside of a grantor’s taxable estate.

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