There are only a few gift tax considerations with respect to revocable trusts. But they can be significant, and understanding them will help you make a more educated, and better, financial and policy decision:
- No gift until the client gives up power to revoke – A direct gift of an asset from a client to a revocable trust will not cause any gift tax consideration, because the client has never parted with dominion and control of the assets placed into the trust. This rule applies up until the moment when the client gives up the right to alter, amend, revoke, or terminate the trust. If the trust becomes irrevocable for any reason during the client’s lifetime—at that moment, since the client can no longer control the use, possession, or enjoyment of the property transferred into the trust—the client has made a gift.
- Note that gift tax consideration are based on the value of trust assets as of the date the grantor parts with dominion and control. For example, assume a client creates a revocable life insurance trust and retains the power to revoke the trust anytime until the youngest beneficiary reaches age twenty-one. At that date, the client loses all dominion and control over the trust’s assets and the gift becomes complete. Gift taxes will be based on the value of the assets in the trust at that time.
- Third party payment of premiums is a gift – If someone other than the grantor of the trust pays premiums while the trust is revocable, the IRS will treat such payments as gifts directly to the grantor even if the payor is a possible beneficiary of the trust or heir to the grantor.
- Gift when policy owned by other than insured is paid to third party – Whenever an insurance policy is owned by one party on the life of a second party and is payable to a third party, there is almost always a potentially serious and adverse tax consequence. For instance, suppose a revocable trust is set up by a client’s wife for the benefit of her children. Suppose she contributed to that revocable trust a $1,000,000 policy on the life of her husband. The IRS will argue that, at the husband’s death, the wife (who as owner, both before and after the transfer to the revocable trust) could have been the beneficiary of the proceeds. When instead, policy proceeds are paid to the trust (i.e., to her children), the wife is making a $1,000,000 (indirect but nevertheless taxable) gift to her children. Since she could have revoked the gift at any time, the gift from the mother to the children did not become complete at the moment of the husband’s death. However, the gift does become complete when the trust becomes irrevocable (or the trust is included in her estate if the power to revoke is retained until death). Furthermore, the value of the gift includes proceeds, which are generally worth substantially more than the value of the policy or premiums when transferred to the trust.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM