Does an Irrevocable Trust Avoid all Taxes?

Irrevocable trust
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An irrevocable trust may not be able to escape the capital gains tax.

Minimizing taxes is a common estate planning goal.

Most people would prefer their assets benefit loved ones or a special charity than the government.

Those who work with an experienced estate planning attorney have better chances than others to accomplish this goal.

An irrevocable trust can protect against estate taxes.
An irrevocable trust may not be the best option when capital gains taxes are involved.

According to a recent Yahoo! Life article titled “Do Irrevocable Trusts Pay the Capital Gains Tax?,” one common tool used by estate planning attorneys for avoiding estate taxes is an irrevocable living trust.

For example, if your home (or other capital asset) is retitled to an irrevocable living trust, then it can be shielded from estate taxes by removing the home from the estate and using your estate tax exemption upon “funding” the trust with the home.

Once the home is placed into an irrevocable trust, it cannot be controlled by the you, the trustmaker.

The trust is a legal entity with its own taxpayer identification number.

An irrevocable trust works to remove assets from an estate by permanently owning the assets transferred to it until the assets are distributed to the trust beneficiaries by the trustee, according to the trust provisions you included in the trust as trustmaker.

Although an irrevocable trust protects against estate taxes, does it do the same for capital gains taxes?

While estate taxes occur after a person has died, capital gains taxes are levied when certain assets are sold.

Homes, businesses, stocks, and collectibles can all be subject to capital gains taxes.

Generally, the tax rate is less than the tax rate on earned income.

For example, the top capital gains tax rate is 20 percent.

The top federal income tax rate is 37 percent.

There is also a threshold for capital gains taxes.

If a single person has taxable income for their capital gains at or less than $41,675, then no tax will be due for 2022.

The same is true for couples who file jointly and have gains at $83,350 or less.

When the trust distributes assets to heirs, it is considered a pass-though entity for income generated in the trust.

This means the beneficiaries will owe taxes on their received income but the trust does not necessarily owe taxes.

Capital gains are not treated as income though.

Rather, they are considered contributions to principal.

When the home or other asset is sold and the gain is not distributed to the beneficiaries of the trust, the trust will be required to pay capital gains taxes.

Watch out when the asset placed in the irrevocable trust is your home!

Special rules apply then the home is sold.

Although individuals can avoid taxes on the first $250,000 on profit from capital gains and married couples can avoid the taxes on the first $500,000, the same is not true for a trust.

It is not a person and does not get this benefit and will be required to pay the full amount in taxes.

Note: to qualify for this capital gains tax exclusion, then home must have been your primary residence for two of the last five years.

Work with an experienced estate planning attorney to determine whether you would benefit from placing your home in an irrevocable trust.

Reference: Yahoo! Life (July 7, 2022) “Do Irrevocable Trusts Pay the Capital Gains Tax?”

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