An irrevocable inter vivos trust (IRT) is a trust created during the settlor’s lifetime, over which settlor retains no power to alter, amend or revoke. Although RLT’s typically become irrevocable on the settlor’s death, they are not called irrevocable trusts. Trusts that are irrevocable from inception are set up for different reasons than a typical RLT. IRTs may be permanently irrevocable, or irrevocable for a specified period of time.
IRTs are useful for a number of purposes because they make possible the removal of property from the estate of the settlor without allowing the beneficiaries to control the property. When an IRT is used in lieu of an outright gift, the settlor can place conditions on any distribution. An IRT can be used to manage property for a beneficiary that is not able, and it can be used to influence behavior of the beneficiary. An IRT avoids probate, but so does an RLT so an IRT is not used primarily for probate avoidance.
The vast majority of the many types of IRTs are designed to save taxes. IRTs may reduce estate tax by removing assets from the estate. IRTs may shift income taxes to beneficiaries in a lower bracket, or they may be drafted in such a way that the settlor remains on the hook for income tax, reducing the size of the estate even further. IRTs may even avoid gift tax if drafted properly. Oftentimes, the tax-saving purpose of the IRT is combined with another purpose such as charitable giving.
Another frequent goal of IRTs is to protect assets from creditors. Under Prob. Code § 18200, irrevocable trusts are not subject to the claims of creditors. Under Prob. Code § 19001, upon death only the portion of the deceased settlor’s estate that was subject to the settlor’s power of revocation is subject to claims of the creditors of the deceased settlor’s estate or expenses of administration.
IRTs are now being used in the area of gun trusts, sometimes for asset protection as firearm collections can be quite valuable, but more recently they are being used to avoid confiscation of firearms by the government. Trusts are not entities and will not avoid application of state transfer laws, but trusts ARE entities under the National Firearms Act (NFA). Recent attempts to broaden that Act to include many common firearms as Title II firearms requiring a federal tax stamp from ATF prior to transfer, have encouraged some to look at an irrevocable gun trust (irrevocable from inception) as a way to maintain firearms for the enjoyment and training of future generations. Making the transfer and paying the tax now to an irrevocable gun trust with dynasty provisions would obviate the need for later transfers. An RLT can also be drafted with dynasty provisions and a tax can be paid at that point, but only an IRT avoids the risk of a confiscatory tax increase between now and death. Furthermore, any non-NFA firearms transferred to the IRT now would probably be “grandfathered” (allowed to avoid payment of the tax) under any future legislation passed requiring them to be registered under the NFA.
The trustee of an irrevocable trust must be chosen carefully, considering possible tax consequences. The settlor should generally not have any powers that would cause the trust to be taxed as a grantor trust, with settlor liable for income tax, unless the trust is intended to be defective in that regard. A tax-sensitive trustee should generally not have discretionary powers over trust property. The settlor can be trustee if the trust instrument requires all current income to be distributed to one beneficiary. However, if there are multiple beneficiaries and the settlor or the settlor’s spouse retains power to sprinkle income among the beneficiaries, this will cause problems under income tax, estate tax, and even gift tax rules. An independent trustee can be given broader discretion. The beneficiary can serve as trustee of its own trust, in circumstances where that is appropriate, and can even be sole trustee of a sprinkling trust benefiting others as well, but to avoid estate inclusion the discretion should be limited to a certain ascertainable standard.
There is a way to qualify gifts to an IRT, even where the instrument does not require all in come to be distributed to the beneficiary on a current basis, using “Crummey” powers. The “Basic Tax Planning” section of this manual discusses these and other tax topics in more detail.