Irrevocable Living Trusts

An irrevocable living trust permanently removes property from the settlor’s estate while creating a separate tax entity. The structure trades flexibility for permanence — once formed, only narrow judicial modification is available.

In a previous post, I discussed revocable living trusts, commonly known as living trusts. A revocable trust is one that the settlor — the creator of the trust — can revoke at any time. Because the trust is revocable, its property is still treated as the settlor’s for estate-tax purposes, and the income of the trust is still treated as the settlor’s for income-tax purposes.

The irrevocable living trust is very different. Once created, the trust cannot be uncreated or revoked, and trust property cannot be removed from the trust except as provided in the trust documents. The property held in the trust is treated as the property of the trust for tax purposes — not the property of the settlor. Irrevocable trusts even have their own compressed income-tax brackets, which reach the top federal rate at much lower income thresholds than apply to individuals (an important planning consideration when allocating income-producing assets).

Nature of the Irrevocable Living Trust

Once created, the terms of an irrevocable trust cannot be changed, nor can the trust be terminated, until the terms or purposes of the trust as specified in the trust documents have been fulfilled. Neither the trustee, nor the beneficiaries, nor the settlor can change the terms of the trust on their own.

Only in rare, extraordinary circumstances can the terms of the trust be changed by court order, and circumstances must have shifted so dramatically as to make the modification a practical necessity. Achieving such a change through the courts is extremely difficult and is available only in the most extreme cases. For example, a trust set up to benefit a university that later dissolves may justify judicial intervention. Many states also recognize “decanting” statutes that permit a trustee to pour trust assets into a new trust with revised terms — but those statutes are limited and turn on careful drafting.

Reasons for Setting Up Such a Trust

There are several reasons to establish an irrevocable trust during your lifetime. (An irrevocable living trust differs from a testamentary trust, which is created through a will after the settlor’s death.)

You may want to give a gift to a child who is bad with money. By placing the money in trust, you ensure that the child receives a regular allowance, with funds distributed in amounts and at times specified in the trust documents. The trust may even pay the child’s bills directly, rather than handing over cash. Through the trust, you can provide for the child while also removing the property from your estate.

You may also have property that you expect will grow in value over the course of your life. By placing the property in an irrevocable living trust, you remove it from your estate, ensuring that a potentially valuable asset is not subject to the estate tax at your death. You can sometimes set up trust terms that allow continued lifetime enjoyment of the property — but this must be done carefully to avoid the property being pulled back into your taxable estate.

Irrevocable living trusts can be useful in many circumstances. Because they are irrevocable, however, they should be formed only after careful consideration and with the assistance of a competent attorney.

Disclaimer: This post is for informational purposes only and is not legal advice. Irrevocable-trust formation interacts with state trust law, the federal estate-and-gift tax framework, and compressed trust-income tax brackets; consult a qualified estate-planning attorney about your situation.

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