Some trusts are "revocable" when recreated, but become "irrevocable" later on. Others are "irrevocable" from the get go.
Regardless, there are tax consequences that just naturally attend any irrevocable trust.
If you are a beneficiary of such a trust, then there are some tax issues of which you should be aware.
This was the message in a recent article from The Motley Fool titled, “Tax Consequences of an Inheritance From an Irrevocable Trust.”
For starters, whether an irrevocable trust will be subject to estate taxation at the death of the trustmaker will hinge on the terms of the trust and how it was created.
Typically, an irrevocable trust is a separate legal entity and, as a result, it is not part of the estate of the trustmaker.
On the other hand, its creation is usually attended by a taxable gift and that can have estate tax consequences in terms of requiring a gift tax return and thereby reducing the eventual estate tax exemption for the estate of the trustmaker.
Yes, this can be rather complicated stuff.
Irrevocable life insurance trusts (ILITs) can be extra tricky.
If the trustmaker who creates the ILIT retains any "incidents of ownership" in the life insurance policy, then the death benefits will be included in the trustmaker's estate.
Obviously, such a misstep would foil the fundamental estate tax planning objective of the trust — to completely remove the death proceeds from his or her estate.
So what are some of these no-no "incidents of ownership"?
Avoid retaining the power to change beneficiaries, cancel or further transfer the policy, use the policy as collateral for a loan, or borrow against the policy's value.
If you retain any of these powers, then estate taxes may be due on the life insurance proceeds thereby decreasing the overall inheritance.
The impact of income taxes also depends on the terms of the irrevocable trust.
As the original article notes, if the trust terminates at the trust creator's death and the trust distributes assets to you as beneficiary, then your tax basis in those assets will be that of the trust.
Make sure you have detailed information from the trustee before making plans to sell those inherited assets.
You may trigger capital gains taxes upon the sale, especially if the assets funding the trust appreciated in value after the trust was created and funded.
What if the trust continues after the death of the trustmaker?
Some complex trust income tax rules will likely apply.
If the trust makes regular distributions to you, then they will be treated as taxable income.
In fact, each year you will receive a year-end informational return showing how much income is taxable and whether it is ordinary income, capital gains, or some other specialized type of income.
Every trust is different.
Make sure you get sage advice from a experienced estate planning attorney.
So, how do you find an "experienced" estate planning attorney?
First, ask around. Friends, family members and other professional advisors are trustworthy sources.
Second, conduct an "organic" search on "Google" for "estate planning" near you (e.g., "Estate Planning Anytown MoKan").
Third, either way, verify. Check out the education, experience, ratings and client reviews of any attorney before you contact him or her.
In fact, I use both of these services to thoroughly vett attorneys before referring members of our "client" family for legal help in other areas of law or for matters in jurisdictions outside Kansas or Missouri.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
For more information about estate planning in Overland Park, KS (and throughout the rest of Kansas and Missouri), visit our estate planning website and be sure to subscribe to our complimentary estate planning e-newsletter while you are there.
Reference: The Motley Fool (October 24, 2015) “Tax Consequences of an Inheritance From an Irrevocable Trust”