Last Updated on October 29, 2022 by Estate Planning FAQ
At first blush, this appears to be a simple answer. A revocable trust can be revoked by the person drafting the document, known as the Grantor. An irrevocable trust cannot be revoked. However, there are a number of differences between the two. This blog post is not intended to identify and describe all the differences. Instead, is more tuned to be a quick reference document to give you the highlights some of the differences.
3 Main Differences
There are three (3) main differences between a revocable trust and an irrevocable trust. This is not to say that there are not other differences in how the revocable trust and the irrevocable trust may operate. However, for purposes of this Article, the the three (3) main differences are:
- Revocability
- Administration and Trustees
- Taxability
Revocability
The first difference as previously stated is one may be revoked while the other may not. A revocable trust allows the person who prepared the document (Grantor) to change their mind and decide that they no longer want the trust as their estate plan or the assets to be held by their trust. Also, as revocable, the Grantor can amend or modify the document as life changes or situations change. The Grantor is free to quit using the trust and the assets can be transferred back into the Grantor’s name. The Grantor continues to be the owner of the asset for tax purposes and any other purpose besides estate administration and it is determined to be owned by the trust. As has been discussed in previous articles without other beneficiary designations in the event the trust would be revoked, the property owned by the Grantor could be subject to a probate administration.
An irrevocable trust, once drafted and signed is effectively, “set in stone”. By this, the terms of the trust are set and the trust and trustee must act pursuant its terms. The document cannot be amended and cannot be revoked for the most part. However, as discussed in other articles, there are some options available if it is determined that the irrevocable trust is not longer needed or there is a need to amend to change beneficiaries. However, in general, once drafted, the trust continues to exist.
Administration and Trustees
Another difference between a revocable trust and an irrevocable trust is that the Grantor is not allowed to be the trustee of an irrevocable trust. A separate person or entity is appointed as the trustee to manage the irrevocable trust. The purposes of an irrevocable trust is to transfer assets out of the estate of the Grantor. When the federal estate tax exemption amount was much lower than it is now, there were incentives to try and reduce estate values for purposes of the estate tax. One method used was to transfer assets to an irrevocable trust. However, for this to occur, the Grantor had to give up all ownership, dominion and control of the asset. The reasoning for this is beyond the scope of this Article.
With a revocable trust, it is very common that the Grantor is also the trustee. Most state laws provide that a Grantor is not authorized to write a trust to defeat claims of his or her creditors. This is commonly known as “the trust is you and you are the trust”.
Another difference between a revocable trust and an irrevocable trust is who is the owner of the assets. When assets are transferred from the Grantor to the revocable trust, although the trustee of the revocable trust is the owner, for all legal purposes except for probate, the assets are still owned by the Grantor. This typically comes up and dealing with issues regarding the estate tax, if the trust or Grantor is sued including whether the assets are available in the event of a marital dissolution.
With regard to an irrevocable trust, when the assets are transferred to it, the irrevocable trust is a separate legal entity. It has its own tax identification number and any transfers that fund the trust the irrevocable trust are considered a completed gift for gift tax purposes. Finally, as it relates to these transfers, provided the same wasn’t done to defraud creditors, funds transferred to an irrevocable trust are no longer owned by the Grantor. This applies in determining the availability of assets for Medicaid planning, estate tax calculations, availability to Predators, Etc. Although there are a number of rules that apply with regard to the availability and whether it is brought back into the estate of the grantor for estate tax purposes, suffice it to say that the assets are excluded from the grand Tours estate.
Has briefly mentioned above, a revocable trust is not a separate legal entity and in fact as the social security number or tax identification number of The Grand Tour. And irrevocable trust has a severally issue tax identification number.
Taxability
The final major difference between a revocable trust and an irrevocable trust is that with a revocable trust, there is not a separate tax return that has to be prepared during the lifetime of the grantor. As previously mentioned above, the revocable trust uses the Social Security Number of the Grantor. It does not have its own tax identification number. As such, all items of income and expense are set forth on the same IRS form 1040 that the Grantor uses for his/her personal income tax return.
With regard to an irrevocable trust on the other hand, as has previously been set forth above, upon its creation and funding, the irrevocable trust does receive its own tax identification number. The irrevocable trust should file an income tax return every year in addition to the income tax return that the Grantor has to file. This is typically completed on IRS form 1041. Although beyond the scope of this particular post, there are also a number of adverse tax consequences when an irrevocable trust has to pay income tax. The rate at which an irrevocable trust must pay income tax can be substantially higher than the rate of the Grantor.
I hope this information was helpful in describing the main differences between a revocable and irrevocable trust that go beyond the obvious.