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Revocable vs. Irrevocable Trust

Once you understand the basics of a trust, you'll need to consider the type of trust that best serves your purposes. An important factor to consider is the flexibility of a trust's provisions, but this must be balanced against your income and estate tax objectives. The complexity of the tax code makes it nearly impossible to have your cake (or keep your hands on your money) and eat it too (protect it from taxes.)

A revocable trust is exactly what the name implies: it is a trust that can be amended or revoked by the grantor after it is created. In contrast, an irrevocable trust cannot be amended or revoked by the grantor after it is created.

A revocable trust becomes irrevocable upon the grantor's death, since the grantor is no longer able to change or revoke the trust.

Trusts designed to avoid federal estate taxes are often drafted to be irrevocable (but not always, as in the case of the bypass trust), while trusts designed only to avoid probate court frequently are revocable. Avoidance of both probate court and estate tax at the same time is more difficult. There can also be significant income tax consequences along the way, so it is important to work with a professional to avoid unpleasant surprises.

Tip

Beginning in 2013, a new 3.8 percent net investment income tax may be imposed on individuals whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for others. Trusts and estates with income over a certain amount are also subject to the NII tax. Form 8960, Net Investment Income Tax - Individuals, Estates, and Trusts is attached to the tax return. For 2013, the IRS has provided taxpayers the ability to rely on more than one set of net investment income tax rules. The best choice varies by taxpayers and depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you.


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