THE DIFFERENCE BETWEEN REVOCABLE AND IRREVOCABLE TRUST PROPERTIES
“What’s the difference between revocable and irrevocable trusts?” It’s not a trick question. The revocable trust is revocable and the irrevocable trust is irrevocable. I don’t mean to be silly, but that’s the difference.
Ok, there are other differences when it comes to the revocable vs. irrevocable trust decision. The income tax, estate tax, and asset protection issues all hinge on whether you have a revocable trust or irrevocable trust.
REVOCABLE TRUST VS IRREVOCABLE TRUST INCOME TAX DIFFERENCES
A revocable trust usually qualifies as a “grantor trust.” In order to be a grantor trust, the trust has to be revocable and the same individual (or group of people) has to be the grantor (guy who puts property into the trust), trustee (the guy who administers the trust property), and the beneficiary (guy who gets the benefits of the trust’s property).
A grantor trust simply uses the Social Security number of the individual as its tax ID number. The standard revocable living trust used in estate planning to avoid probate is a grantor trust. When Mom and Dad set up a trust, they will hold all three positions.
When you use the living trust, you’ll just use your Social Security number as the living trust’s tax identification number. You will file your 1040 form just like you always have. The living trust is basically invisible to the IRS.
Note that if you are not holding all three positions in the trust, it is not a grantor trust and the trust will need to get its own tax ID number and file taxes.
You want a grantor trust for your basic estate planning. In my new edition of Protecting Your Financial Future, I am careful to make sure you understand the difference in all the trusts so you can make the revocable vs. irrevocable trust decisions and not just blindly trust your lawyer.
By the way, Protecting Your Financial Future has been a Time-Warner Book-of-the-Month Club book. It is easy to read and actually funny. Order it now and get the free DVD, Using the Law to Make Money and Protect Your Assets (a $19.99 value).
The primary irrevocable vs. revocable trust difference is most irrevocable trusts are not grantor trusts. The standard irrevocable trust has beneficiaries other than the grantor(s). Irrevocable trusts are usually their own taxing entity.
With an irrevocable trust, such as a children’s trust (IRS Code 2503), or an irrevocable life insurance trust (ILIT), the trust will get an IRS tax ID number and file a tax return each year.
ASSET PROTECTION DIFFERENCE BETWEEN REVOCABLE AND IRREVOCABLE TRUST STRUCTURES
Because a revocable trust is revocable, you can get the assets of the trust back at any time. All you have to do is revoke the trust. It doesn’t matter who the beneficiary is. If the trust is revocable it won’t give you any asset protection. A key point when comparing recovable vs. irrevocable trusts.
You will get into court, and the judge will simply say revoke the trust and bring all the assets back for your creditor. You lose!!
There is a difference between revocable and irrevocable trust structures in the case of asset protection. If the trust is irrevocable, you have to give up the trust property permanently to the trust when you establish the trust. You can’t just revoke the trust and get the property back. Therefore, the courts can’t make you revoke the trust and get the property back.
The property in an irrevocable trust will usually be protected from your creditors, but you can’t be the beneficiary. You have given the property away to the irrevocable trust, and it’s not yours anymore.
Note that it will “usually” be protected. The protection difference in the irrevocable trust will hinge on the rights the grantor (you) reserve to yourself to be able to manage and manipulate the trust property. If your rights effectively make it so you can enjoy all the rights of ownership of the property, then the courts may be able to get it.
When you are making the revocable trust vs. irrevocable trust decision, you will need to evaluate what your asset protection goals are and how many rights to enjoy the property you are willing to give up.
Learn more about trusts in my book, Protecting Your Financial Future.