Tax Issues for Revocable Living Trusts
NOTICE
The following sections discuss certain Internal Revenue issues. PLEASE NOTE THAT THIS IS FOR REFERENCE FOR OUR CLIENTS AND IS INTENDED TO BE A STARTING POINT FOR YOU IN YOUR DISCUSSIONS WITH YOUR TAX ADVISOR. This is not intended to be a comprehensive discussion but merely seeks to answer some basic questions which may arise.
SEE YOUR TAX ADVISOR!
When to Get a New Tax Identification Number
for a Revocable Living Trust
According to the Internal Revenue Service (IRS) the Trustee of a revocable trust should file annual income tax returns (Treas. Reg. 1.671-4), and obtain an employer identification number. (Rev. Rul. 63-178, 1963-2 C.B. 609) IRS Form 1041 when the trust is revocable.
HOWEVER, if the grantor or settlor of a revocable trust or his or her spouse is a trustee of that Trust, then the items of trust income and deduction are reported directly on the Settlor’s own tax return and the trust uses the Settlor’s Social Security Number rather than obtaining a separate taxpayer identification number for the trust. (Treas. Reg. 1.6012-3(a)(9)).
In general, if at least one of the Settlors are also the Trustee for the Trust, then the use of the Settlor’s Social Security Number is recommended. If on the other hand someone other than the Settlor(s) is acting as Trustee (during one or more of the Settlor’s lifetimes), then the use of a separate employer identification number may be preferable. Keep in mind that once a Revocable Living Trust becomes irrevocable, such as upon the death of the Settlors, that the Successor Trustee must usually obtain a separate employer identification number.
Income Tax Considerations
In general, the creation of a revocable trust has no significant income tax consequences during the Settlor’s lifetime. Because the trust is revocable, its income is fully taxed to the Settlor under the grantor (Settlor) trust rules regardless of whether it is distributed or accumulated. (I.R.C. 676.) The transfer of property to a revocable trust generally does not constitute a taxable event or otherwise trigger the realization of gain.
Asset Holding Periods
The holding period of assets transferred to a revocable trust includes the holding period of the assets in the hands of the settlor. Once the trust ceases to be revocable (for example, on the settlor’s death), the holding period begins anew. (Rev. Rul. 73-209, 1973-1 C.B. 614)
Sale of Principal Residence
Generally, the tax advantages on the sale of settlor’s principal residence are retained even if the residence is held in a revocable trust. (I.R.C. 121, Rev, Rul. 66-159, 1966- C.B. 152; IRS Letter Ruling 8007050)
Deductibility of Attorney Fees
The costs of establishing and maintaining a funded revocable trust will be borne in part by the federal government because such fees are incurred for the management, conservation, or maintenance of property held for the production of income and are deductible for federal income tax purposes to a considerable extent. (I.R.C. 212) These costs are, of course, subject to the two percent floor on miscellaneous deductions, under the Tax Reform Act of 1986.
In addition, legal fees incurred in establishing a revocable trust should be deductible on the same basis as that on which trustee’s fees are deductible. In fact, it may not seem unreasonable to regard the entire charge made by the attorney as allocable to the establishment of an arrangement for the management, conservation, or maintenance of property held for the production of income, at least if the trust is to be presently funded.
Once again see your tax adviser.