A revocable trust is an arrangement in which the grantor (i.e., trust settlor) has the authority to modify, change, or cancel the trust, and the grantor still has access to the property placed in trust.
In contrast, an irrevocable trust is an arrangement where the grantor 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.
Revocable trusts are generally used for estate planning purposes to avoid probate. Probate is the court-supervised process of administering a person’s estate. A court reviews the decedent’s will and appoints an executor or personal representative to administer the estate. Using a revocable trust avoids having to probate any assets placed within the trust. Upon the settlor’s death, the trustee manages and distributes the trust assets according to the terms of the trust agreement.
Asset Protection Reasons
Revocable trusts generally do not provide asset protection to the grantor. The grantor can still access assets placed into the trust, so creditors can typically invade a revocable trust to satisfy debts. In contrast, property placed in an irrevocable trust is no longer the grantor’s property, so it is beyond the reach of creditors.
U.S. Federal Tax Consequences
Revocable trusts are generally grantor trusts for U.S. federal estate and income tax purposes. The grantor is the owner of the trust property, so the grantor must report any income, expenses, or credits earned within the trust. The grantor is then responsible for paying income taxes on those net earnings.
Property transferred to a revocable trust is generally not a completed gift for federal tax purposes, so the grantor is not required to file Form 709 (U.S. Gift & GST Tax Return). There are different rules for unique trust arrangements, such as the Intentionally Defective Grantor Trust (IDGT).
Federal Tax Filings for Revocable Trusts
Given that revocable trusts are grantor trusts, they are generally not required to file Form 1041 (US Income Tax Return for Estates & Trusts). However, a grantor trust with an employer identification number (EIN) should file a grantor trust Form 1041.
The grantor trust Form 1041 notifies the IRS the income reported under the trust’s EIN will ultimately be reported on the grantor’s tax return.