An irrevocable trust is an arrangement in which the grantor (i.e., trust settlor) cannot modify or cancel the trust after its creation. Once the grantor transfers property into an irrevocable trust, it belongs to the trust, not the grantor. In contrast, a revocable trust gives the grantor the authority to modify, change, or cancel the trust, and the grantor still has access to the property.
The trust grantor uses an irrevocable trust to protect assets and limit the grantor’s exposure to gift and estate taxes. By placing assets into an irrevocable trust, the property no longer belongs to the grantor. If creditors want to pursue the grantor for unpaid debts, the trust property is generally exempt because the grantor can no longer access those funds.
When a grantor places assets into an irrevocable trust, those assets are no longer part of the grantor’s estate. Therefore, those assets are not subject to estate taxes when the grantor passes away. However, property transferred to an irrevocable trust is generally subject to gift tax and gift tax reporting on Form 709 (U.S. Gift & GST Tax Return).
Grantor Trust vs. Non-Grantor Trust for Federal Tax Purposes
Irrevocable trusts are further classified as either grantor or non-grantor for federal income tax purposes. With a grantor irrevocable trust, the grantor is still treated as the owner of the property for tax purposes, which means any income earned within the trust is still taxable to the grantor.
With a non-grantor irrevocable trust, the trust is the owner of the property for income tax purposes, and the trust is liable for income taxes on the net income. Non-grantor trusts must file Form 1041 (US Income Tax Return for Estates & Trusts) to report the trust income, expenses, credits, and tax payments.