Because the assets in the Trust no longer belong to you, you cannot count them among your estate, and therefore you don't have to pay estate taxes on them.
Reasons For Choosing An Irrevocable trust
Irrevocable Trusts are generally established in an effort to avoid or reduce taxes. Since the assets are no longer considered your property, you are not responsible for paying taxes on those assets.
Control Of Assets In The Trust
Putting assets into an Irrevocable Living Trust can be understood as giving the assets to someone else (the Trustees) to manage. In addition, you (the grantor) forfeit any rights to the control or management of the assets, including the right to sell, give away, invest, or otherwise manage the property in the Trust.
Control Of Terms Of The Trust
You give up all rights to control the terms and conditions of the Trust after it's nitially established. This means you can't change the beneficiaries or the terms or conditions under which beneficiaries will receive the property in the trust. In addition, you can't revoke or terminate the Trust without the consent of the beneficiaries and Trustees.
Any assets transferred to an Irrevocable Trust are subject to federal gift tax. The 2013 annual gift tax exclusion is $14,000, which means that up to $14,000 in assets may be transferred to the trust tax-free. Any assets exceeding $14,000 will be taxed through the United States Gift (and Generation-Skipping Transfer) Tax Return (Form 709).
However, as we've already established, when you put your property into the trust it's no longer yours and therefore you don't have to pay estate taxes on that property.
How Irrevocable Trusts Protect Assets
Irrevocable Trusts are often established in order to protect assets when the beneficiary is under 18 years old, a person with a disability, or a financially irresponsible adult. There are a number of specific Irrevocable Trusts (specifically a "Spendthrift Trust" and a "Special Needs Trust") that are designed to distribute funds according to a specified schedule, while keeping the remaining funds inaccessible to the beneficiary, the beneficiary’s creditors, or the beneficiary’s caretakers. If you'd like to set up a Trust of this nature, it's best to meet with a trust and estate attorney.
How Irrevocable Trusts Avoid Or Reduce Estate Taxes
When a person with a significant amount of assets dies and transfers those assets to others, either through a Will or through the laws of intestacy, the transferred assets are subject to a federal estate tax. Estate tax returns are required of all estates with a value of over $5,000,000. By transferring property to an Irrevocable Trust, the property is no longer considered an asset of the person who died, and can't be counted toward the deceased’s taxable estate.
Using Irrevocable Trusts In Medicaid Planning
Irrevocable Trusts can also be established in preparation for applying for Medicaid benefits, specifically for long-term care benefits. Since long-term care can be very expensive, it may be beneficial for some people to put the bulk of their assets into an Irrevocable Trust so that they have a smaller net worth, which will qualify them for long-term care Medicaid benefits. Depending on the state in which you live and the laws of that state, the rules and requirements around using Irrevocable Trusts in Medicaid planning can vary.
Related Trust article: Revocable Trusts