Revocable Living Trust Taxes

The basics of a revocable living trust are simple: You create a living trust while you’re alive and well and you can alter the terms at any given time.

You distribute assets to yourself while you’re of sound mind, and when you pass away a successor trustee takes over and distributes your assets according to your wishes.

As simple as it all sounds, it’s actually a very thorough process that contains a lot of detail. For example, what taxes do you have to pay on a living trust? And how is a revocable trust taxed after death?

Keep reading as we take a deeper look into these questions and more.

What is a Revocable Living Trust?

The revocable living trust has been a significant estate-planning tool for many years and is the foundation for most estate plans. It provides privacy, while avoiding probate and family in-fighting. It ensures the right money gets into the right hands at the right time.

As the trustmaker of the revocable living trust, you are also the trustee. This means that you are the person who controls the assets in the trust and handles the administration – such as tracking income and tax returns.

What are the Benefits of Putting Your Assets into a Revocable Living Trust?

While a living trust does not provide asset protection, like an irrevocable trust, it is flexible and is the basis of many family estate plans. Compared to other legal documents, such as wills, revocable living trusts provide benefits such as increased privacy and more flexibility.

Here are the top 5 advantages of a revocable living trust.

Avoid Probate – One of the biggest advantages of revocable living trusts is the avoidance of probate. Assets held in a trust avoid probate because the trust itself doesn’t diminish with the trustmaker.

Flexibility – Many individuals find that flexibility to alter their living trust as they see fit is best suited for their situation.

Privacy – Living trusts are never filed with a court, therefore they do not become public record. As mentioned above, living trusts also help avoid probate, which keeps your records out of public proceedings.

Avoid Guardianship or Conservatorship – If you were to become disabled or incapacitated, your assets would be subject to the restrictive rules of guardianship or conservatorship. A revocable living trust allows you to name a successor trustee so that someone can manage your trust and assets for you if you can no longer do it yourself.

Continuous Management – By naming a professional trustee to manage your property, the wealth that you’ve accumulated can continue to grow for multiple generations and you can put restrictions on the income or withdrawals.

Revocable Living Trust Taxes

From an income tax standpoint, revocable living trusts are the simplest of all trust arrangements. Because the trustee (the creator) has full control over the terms of the trusts and assets, any income generated by a revocable trust is taxable to the trustee during their lifetime.

All items of income, deduction, and credit will be reported on the trustor’s personal income tax return, and no return will be filed for the trust itself. Revocable trusts are considered “grantor” trusts for income tax purposes. Which means they are practically invisible to the IRS and state taxing authorities.

Here’s a brief overview of taxes during a Grantor’s life and after:

Revocable Living Trust Taxes during Grantor's life

As the Grantor of a living revocable trust, you can amend the trust whenever - and however- you want. You can move assets, establish rules, or even terminate the trust at any given time. As the Grantor, you will receive all financial benefits of the trust. This means the IRS will still tax you on assets like investments and bank accounts because you will file a separate tax return for a revocable living trust.

Revocable Living Trust Taxes after Grantor’s Death

Unless terminated, a revocable living trust is still legal after the Grantor’s death. The taxes affect both the beneficiaries and the estate. Upon death, the trustee of the revocable living trust files a final tax return and takes over the income through the trust. However, the income earned after death is reported on a separate tax return for the trust - not on the trustees tax return or the final tax return of the Grantor (you).

Revocable living trusts offer no tax benefits. Shifting assets into a revocable trust won’t save income or estate taxes. You will need to work with an attorney to implement appropriate tax-reduction strategies.

Should You Set Up a Revocable Living Trust?

When working with an attorney, you’re looking at paying upwards of $2,000 for a revocable living trust. This often raises the question, do the benefits of a living trust outweigh the costs? The answer is always it depends solely on your unique situation, goals, and assets.

Anyone with assets that are titled solely to themselves that wants to leave those assets to family or friends if they become incapacitated or pass away, should consider a revocable living trust. Not all living trusts are created equal, so these documents can benefit single individuals, married couples, or people with minor children.

Individuals often consider revocable living trusts because the advantages and benefits do outweigh the costs and disadvantages. Avoiding thousands of dollars in probate, maintaining privacy, and having the ability to control assets is all some people want and need.

Whether a revocable living trust is the right choice for you and your beneficiaries depends greatly on your specific needs and circumstances. The decision to create one requires a thorough legal analysis of several factors as they affect each individual and family. Consult with an experienced attorney to help you navigate the process.