Overpaying Uncle Sam

Dear Stan,
There are basically two types of trust: Revocable and irrevocable. A trust is created when a person (the grantor) transfers assets for the benefit of either themselves or others or a combination of both. A trust's assets are governed by the trust document that expresses the grantor's wishes.

The grantor can make the transfer of the assets permanent, in which case the trust is irrevocable. The creation of an irrevocable trust is a current gift to the beneficiaries and would not be included in the grantor's taxable estate at his death.

Since gift tax and estate tax are essentially the same tax on the value of the assets, in certain circumstances it makes sense to make a gift currently rather than wait until death. For example, an individual may irrevocably transfer a rental property or stock portfolio to a trust to lock in the current value as a gift rather than wait until their death when the value of the asset is greater. The downside is that the grantor no longer controls the assets transferred and cannot later change the trust beneficiaries.

If an individual wants to transfer assets but retain control of their disposition he would create a revocable trust. The trust document allows the grantor to change the trust terms at any time -- he can change the beneficiaries, reclaim transferred assets and break the trust if he so wishes. Since the grantor retains control of the assets to his death, the trust is includable in the taxable estate of the grantor. Since the assets formed part of the decedent's taxable estate, the trust or trust beneficiaries receive a stepped-up basis to the fair market value of the assets at the time of the grantor's death. For tax purposes it is treated the same as if the assets were inherited without regard to the trust.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.