Beware the Many Downsides to an Irrevocable Trust  

Beware the Many Downsides to an Irrevocable Trust  

By Attorney Paul Hanks Ironclad Living Trusts in California

My law firm receives many inquiries regarding irrevocable trusts. As an estate planning lawyer I remark to the ears of those callers to beware the depth of the many dangers that come with an irrevocable trust. Upon calling my law firm many people are shocked to learn that an irrevocable trust can be a very risky choice for a trust.

I can quickly dispense of the upsides for an irrevocable trust. One benefit of an irrevocable trust is limited to the super rich. Most of us have no concern about the death tax for the reason that there are very favorable laws that insulate most estates from that tax. In another blog I alluded to the fact that the federal exemption shields most estates from the death tax. That exemption has largely eliminated the death tax and now stands at almost 14 million dollars for single persons and close to 28 million for married couples. If your wealth exceeds those limits then an irrevocable trust may be an option.

The second reason for an irrevocable trust is liability protection, but which is not as airtight as many people believe. Many people having creditor issues create an irrevocable trust to evade their debts, but the truth of the matter is that a judge can undo that transfer. Moreover, even if the irrevocable trust was not a device to dodge your obligations, there is still risk depending on the nature and use of the property in that trust. Many people are surprised to learn that the trustee under an irrevocable trust can be sued. And if you have named a family member as the trustee so that you can influence them, disaster lurks. This is for the reason that the moment you create an irrevocable trust it must be assigned a federal tax identification number. Since the trust is on the radar screen of the IRS there is a high number of audits of irrevocable trusts.

And there are many more downsides that come with an irrevocable trust. An irrevocable trust cannot be amended, and worse yet you are conveying legal title to your assets to the beneficiaries under that trust. Good luck trying to obtain an equity line of credit after you have deeded your home into an irrevocable trust. Once an irrevocable trust is signed the named beneficiaries actually have control over all your assets in that trust. The person creating an irrevocable trust cannot be the trustee (or manager) of the assets tucked into that trust. Therefore it is an independent trustee who will manage all property of the trust and exert exclusive control over a bank account in the name of the trust. The trust bank account is funded with money that used to belong to the trust creator. The trustee and not you will control that bank account to service obligations tied to trust property and expenses of the trust.

Despite the liability protection feature of an irrevocable living trust, whoever you name as trustee under an irrevocable trust can be sued in their capacity as trustee and force the trust to defend itself in court – an example would be if a home were in an irrevocable trust and there was an injury accident at the home. Thus even where an irrevocable trust is in place it is very important to have the proper insurance coverages in place. Another downside to an irrevocable trust is that it jeopardizes the valuable step up in tax basis on your home which is critical for insulating your home from a capital gains tax liability.

Yet another drawback to an irrevocable trust is its maintenance – upon its creation an irrevocable trust must obtain a tax ID number and, unlike a revocable living trust, file a separate set of tax returns on an annual basis during the entire remaining lifetime of the trust creator.

There is an old adage that comes to mind with irrevocable trust, look before you leap. If you fail to look before deciding to put an irrevocable trust in place, you could be harming yourself in many ways. And it can be very difficult if not impossible to exit from an irrevocable trust, and if you nonetheless tried to do so, tax liabilities may follow. Beware of irrevocable trusts, and carefully examine all your options before choosing the type of trust that is the best fit for your needs.

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