Under a trust arrangement, a grantor funds the trust with assets and transfers these assets to a trustee, who holds them for the benefit of one or more beneficiaries. Trust assets are distributed to beneficiaries under terms established in the trust document. A trust is revocable if the grantor can change or terminate it at any time during his lifetime. If you owe overdue federal taxes, creating a revocable trust cannot protect you from the IRS.
Pass-Through Taxation Status
A revocable trust is subject to “pass through” taxation status because the IRS does not consider a revocable trust to be an independent taxable entity. This means that, for tax purposes, the IRS will ignore the revocable trust. Instead, the IRS will tax you on all trust income, and the IRS will consider trust assets to be your property. The reasoning behind this taxation status is that since you retain the power to revoke the trust, you have not really parted with your ownership rights, and thus the trust is not independent of you.
The revocability of a trust depends on state law and the trust document that creates the trust. The trust document spells out the basic terms of the trust, and a well-drafted document will state specifically whether the trust is revocable or irrevocable. If the trust document is silent on the issue of revocability, its status depends on state law. As of 2013, in the 25 states that have enacted the Uniform Trust Code, a trust is revocable unless the trust document specifically states it is irrevocable. In addition, Section 676 of the Internal Revenue Code specifically defines revocability for purposes of federal taxation.
Since the IRS considers the assets of a revocable trust to be your property, for tax purposes, the IRS and other creditors can reach these assets to satisfy your debts. As with any taxpayer, the IRS will assess taxes against you before they come due, to give you time to pay. If your tax liability becomes overdue, however, the IRS may eventually levy against your assets, including assets held in a revocable trust. A levy is a physical or legal seizure of your property to satisfy a tax debt.
Execution of a Levy
The IRS must send at least two notices before executing a levy – a Notice and Demand for Payment and, if your delinquency continues, a Final Notice of Intent to Levy and Notice of Your Right to a Hearing. It may send notices to the trustee to levy on any of your property held in a revocable trust. The IRS can place a levy on any type of property. The IRS may physically seize a movable asset, such as jewelry or an automobile, remove your name from a real estate title deed or seize funds from your bank account. The IRS is entitled to order a third party, such as the bank holding the trust account, to comply with its demands.
- ACTEC: Summary of States that Adopted the Uniform Trust Code and those States’ Treatment of Exception Creditors
- Colorado Bar Association: Section 602: Revocation or Amendment of Revocable Trust
- Tax Almanac: Internal Revenue Code: Sec. 676. Power to Revoke
- Internal Revenue Service: Levy
- Ohio State Bar Association: Revocable (“Living”) Trusts
- Internal Revenue Service: Memorandum Number 200815001
- Jupiterimages/liquidlibrary/Getty Images