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What is an Irrevocable Trust

Irrevocable Trusts for Tax Planning and Asset Protection

The legal arrangement known as an Irrevocable Trust is one of the most important tools for both business and personal planning.   An Irrevocable Trust can produce significant business, tax and asset protection advantages in addition to traditional estate planning benefits.

Distinguishing Revocable Trusts

Before we discuss the particular planning opportunities of an irrevocable trust lets briefly review what the term “trust” means. Remember that a trust is an arrangement where one person, (the trustor) transfers money or other property to another  (the trustee) who agrees to hold the property according to the terms specified in the agreement. The trust agreement specifies what the trustee is required or permitted to do with the property – how he or she is to hold it, for how long and who is to receive any benefits. Those who are entitled to receive the benefits of the trust are called the beneficiaries.

A trust which is revocable, such as a typical living trust used in estate planning, is one that can be cancelled or changed in any way, during the trustor’s lifetime.  A revocable trust is often used to avoid a probate of the trustor’s estate and to provide a structure for holding and distributing assets upon the death of the trustor. Because of these unrestricted powers over trust property, during lifetime, the assets of a revocable trust are generally treated as owned by the trustor, for all legal and tax purposes.

Purposes of Irrevocable Trusts

An irrevocable trust is generally designed to accomplish a specific business, tax or estate planning purpose which involves removing particular assets from the trustor’s “balance sheet.”  Depending on the particular goal and what is intended to be achieved, an irrevocable trust provides appropriate restrictions on the powers of the trustor and trustee so that relevant legal and tax rules are properly accounted for.

Tax Trusts

For example, an individual may wish to shift taxable business or investment income to lower bracket family members to achieve  tax savings. A typical revocable trust, with unrestricted powers retained by the trustor will not be effective in shifting income to another taxpayer.  The trustor will still be considered the owner of trust property for tax purposes.

By contrast, an irrevocable trust, for these purposes, is one which sufficiently restricts the trustor’s powers over the trust, in a manner consistent with the specific rules of IRC Sections 671-679. If the rules are followed, the trustor is not treated as the owner of trust property for income tax purposes and the tax planning goal can be achieved.

Similarly, if one is attempting to reduce the size of an estate, to reduce or eliminate estate taxes, assets are often transferred to an irrevocable trust. The powers which can be maintained by the trustor are narrowly drawn and the limitations on the trustor’s powers must be strictly adhered to if property is to be successfully removed from the estate to avoid estate taxes

Irrevocable Trusts for Liability Protection

Irrevocable trusts can be used to minimize potential liability from a property or to protect the assets in the trust from the claims of a trustor’s or beneficiary’s future creditors. To protect trust assets from a future creditor claim, state laws and sometimes federal bankruptcy law must be properly applied. Some states allow a trustor to maintain strong powers to manage trust assets and to control the timing and direction of the trust fund and even to receive current income distributions.


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