A revocable living trust can offer various benefits, but saving on taxes is generally not one of them — at least not during the grantor’s lifetime. Here’s how it breaks down:
Income Taxes: For income tax purposes, a revocable trust is generally transparent. The grantor/settlor, or person who creates the trust, retains control over the assets and can change or revoke the trust at any time. Therefore, the Internal Revenue Service (IRS) considers the trust’s income as the grantor’s income, and it is reported on the grantor’s personal income tax return. This means there’s no income tax benefit to transferring assets into a revocable trust.
Estate Taxes: At the federal level, revocable trusts do not save on estate taxes. The assets in the trust are still considered part of the grantor’s estate for estate tax purposes. However, revocable trusts are often used in estate planning to manage and control the distribution of assets after the grantor’s death, and while they do not reduce estate taxes, they can help in structuring assets in a way that maximizes the use of state and federal estate tax exemptions.
Gift Taxes: Transferring assets to a revocable trust is not considered a completed gift for gift tax purposes because the grantor retains the ability to revoke the trust. Therefore, there is no gift tax benefit associated with transferring assets to a revocable trust.
Capital Gains Taxes: When the grantor of a revocable trust dies, the assets in the trust typically get a step-up in basis to their fair market value at the time of the grantor’s death. This can reduce capital gains taxes if the assets are sold by the trust after the grantor’s death.
Generation-Skipping Transfer Taxes: Like with estate taxes, assets in a revocable trust are still part of the grantor’s estate and are subject to generation-skipping transfer taxes. There are no direct savings on these taxes simply by having assets in a revocable trust.
Property Taxes: Holding property in a revocable trust generally does not provide a property tax benefit.
Having a revocable trust may have ancillary benefits that can indirectly affect taxation, such as avoiding probate, which can reduce the costs and time associated with transferring assets upon death. Probate savings are not necessarily tax savings, but they can still be financially beneficial.
It’s important to note that while revocable living trusts may not provide direct tax benefits, irrevocable trusts — which cannot generally be modified or revoked — can sometimes be structured to save on estate and gift taxes. However, the grantor must give up control over the assets placed into an irrevocable trust, which is a significant difference from a revocable trust.
Tax laws can be complex and frequently change, and tax-saving strategies often depend on individual circumstances. For this reason, it is advisable for individuals to consult with an estate planning attorney or a tax professional to explore the most effective strategies for their particular situation.