Christopher S. Mulvaney,

Attorney and Counselor-at-Law

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Gonzaga University School of Law – Spokane, Washington – Class of 2002 – Cum Laude The Latin phrase “Deo patriae, scientiis, artibus” translates to “For God and country through sciences and arts”.  The initials A.M.D.G. on the seal of Gonzaga Law School stand for Ad Majorem Dei Gloriam, which is Latin for “For the Greater Glory of God” the Motto of the Society of Jesus (Jesuits): a Catholic religious order founded by St. Ignatius of Loyola.

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The IRS treats revocable living trusts and irrevocable living trusts differently for tax purposes, primarily because of the level of control the grantor retains over the trust assets. 

Here’s a breakdown of the key differences:

Revocable Living Trusts:

• IRS Disregarded Entity: For tax purposes, a revocable living trust is considered a “grantor trust.” This means the IRS essentially ignores the trust as a separate tax entity during the grantor’s lifetime.
• Grantor Pays Taxes: All income generated by the trust’s assets is reported on the grantor’s personal income tax return (IRS Form 1040).
• No Separate Tax Return (Usually): While the grantor is alive, the trust does not typically need to file its own tax return (IRS Form 1041).
• Assets Included in Estate: Assets held in a revocable trust are considered part of the grantor’s taxable estate for estate tax purposes.
• Step-Up in Basis at Death: Assets in a revocable trust receive a step-up in basis at the grantor’s death, which can reduce capital gains taxes for beneficiaries when they sell the assets. 

Tax Treatment of Revocable vs. Irrevocable Trusts

Irrevocable Living Trusts:

• Separate Taxable Entity: An irrevocable trust is treated as a separate legal and tax entity by the IRS.
• Files Its Own Tax Return: The trustee of an irrevocable trust must obtain a separate taxpayer identification number (TIN) and file its own tax return (Form 1041) to report income, deductions, gains, and losses.
• Potential for Tax Advantages: Irrevocable trusts can offer tax benefits, such as removing assets from the grantor’s taxable estate for estate tax purposes.
• Compressed Tax Brackets: Irrevocable trusts are subject to compressed tax brackets, meaning income retained in the trust is taxed at higher rates faster than for individuals.

Irrevocable trusts, like estates, are subject to federal income tax at rates that are generally more compressed than those for individual taxpayers. This means that the top tax brackets apply to trusts at much lower income levels compared to individuals. 

Here are the compressed federal income tax brackets for irrevocable trusts (and estates) for tax year 2025 (taxes paid in 2026): 

Taxable Income	Tax Rate
$0 – $3,150	10%
$3,150 – $11,450	24%
$11,450 – $15,650	35%
Over $15,650	37%

For comparison, note that the top individual income tax rate of 37% applies to single filers with taxable income over $626,350 in 2025. 

Long-Term Capital Gains Tax Rates for Trusts in 2025: 

• 0%: For capital gains up to $3,250
• 15%: For capital gains between $3,250 and $15,900
• 20%: For capital gains over $15,900 

It’s important to remember:

• These rates apply to income that is not distributed to beneficiaries.
• Distributions of income are generally taxable to the beneficiary, while distributions of principal are not.
• Trusts may be subject to the Net Investment Income Tax (NIIT) of 3.8%. 

Consult with a financial advisor or tax professional to understand the specific tax implications for your irrevocable trust. 

• Distributions to Beneficiaries: Income distributed to beneficiaries is generally taxable to them, while distributions of principal are not subject to income tax.
• No Step-Up in Basis at Death (Generally): Assets transferred to an irrevocable trust during the grantor’s lifetime generally do not receive a step-up in basis at death, unless the assets are included in the grantor’s taxable estate. 

In summary:

The key difference in tax treatment is that a revocable trust is transparent to the IRS during the grantor’s lifetime, with all tax responsibility falling on the grantor. An irrevocable trust, on the other hand, is a separate tax entity with its own tax obligations and potential tax advantages, such as estate tax reduction.

How does the IRS tax revocable living trust after the grantor dies?

After the grantor (the person who created the trust) of a revocable living trust dies, the trust’s tax status changes significantly

1. Transition from Grantor Trust to Irrevocable Trust:

• While the grantor is alive, a revocable living trust is typically considered a “grantor trust” for income tax purposes, meaning the income and deductions are reported on the grantor’s personal income tax return using their Social Security Number.
• Upon the grantor’s death, the trust becomes irrevocable, and it becomes a separate tax entity. 

2. Obtaining a Taxpayer Identification Number (EIN):

• The successor trustee must obtain a separate Taxpayer Identification Number (TIN), or Employer Identification Number (EIN), for the trust. This is required even if the trust had a TIN during the grantor’s lifetime.

Taxpayer Identification Number (TIN) is a broad term that refers to any identification number used by the IRS to administer tax laws. It’s a general identifier for taxpayers. 

Employer Identification Number (EIN) is a specific type of TIN used to identify businesses, organizations, trusts, and estates. Think of it as a Social Security number for businesses. 

Here’s a breakdown of the key differences:

TIN:

• Definition: A general identifier used by the IRS for tax administration.
• Purpose: Used for various tax-related activities, such as filing returns.
• Types: Includes SSNs, EINs, ITINs, ATINs, and PTINs.
• Issued by: Either the SSA or the IRS. 

EIN:

• Definition: A nine-digit number specifically assigned by the IRS to business entities.
• Purpose: Used to identify employers and other entities like corporations and partnerships.
• Issued by: The IRS. 

In short: A TIN is a broad category encompassing various tax identification numbers, while an EIN is a specific type of TIN designated for businesses and similar entities. A TIN can sometimes be used in place of an EIN, but an EIN cannot be used in place of a TIN. 

• This EIN will be used to report the trust’s income and file its own tax returns. 

3. Filing a Fiduciary Income Tax Return (Form 1041):

• The successor trustee will need to file an annual fiduciary income tax return, IRS Form 1041, to report the trust’s income and tax liability after the grantor’s death.
• This form reports income, deductions, gains, and losses related to the trust’s assets. 

4. Reporting Income to Beneficiaries:

• If the trust distributes income to its beneficiaries, the trust can deduct those distributions on its tax return.
• The beneficiaries will then receive a Schedule K-1 from the trustee, reporting their share of the trust’s income.

• Beneficiaries must include this income on their own individual income tax returns. 

5. Estate Tax Considerations:

• Assets in a revocable living trust are subject to federal and state estate taxes as part of the deceased’s gross estate.
• The executor and trustee may need to work together to determine if estate taxes are due and file the appropriate estate tax return (Form 706). 

6. Section 645 Election:

• A Section 645 election allows a qualified revocable trust to be treated as part of the grantor’s probate estate for federal income tax purposes.

• This election simplifies tax reporting by permitting a single tax return for both the estate and the trust. 

7. Income Tax Issues for the Year of Death:

• For the year the grantor dies, the trustee must allocate income, losses, deductions, and credits between the grantor’s final tax return and the trust’s return for the periods before and after death. 

Important Notes:

• Trust taxation after the grantor’s death can be complex and depends on the specific trust terms and assets.
• It is strongly recommended that the successor trustee consult with a tax professional in addition to Christopher S. Mulvaney for guidance.

Generally, a successor trustee of a revocable living trust that becomes irrevocable after the death of the grantor does not have the option to elect to pay taxes at the individual rate of either the successor trustee or the beneficiaries for income retained within the trust. 

Here’s a breakdown of how it works:

• Trust becomes a separate taxpayer: Upon the death of the grantor, a revocable living trust becomes irrevocable, and it becomes a separate taxpaying entity. The successor trustee must obtain a separate taxpayer identification number (TIN) for the trust.
• Trust tax rates apply: The income earned by the trust after the grantor’s death that is retained within the trust is taxed to the trust at the compressed trust tax rates, which are generally higher than individual tax rates.
• Income distributed to beneficiaries: If the trust distributes income to the beneficiaries, the beneficiaries are responsible for paying income tax on that income at their own individual tax rates. The trust would deduct the distributions on its tax return, essentially shifting the tax burden to the beneficiaries. 

How the trustee can influence tax liability:

While the trustee cannot choose which individual’s tax rate applies to the trust’s retained income, the trustee can strategically manage distributions to beneficiaries to potentially minimize the overall tax burden. 

• The 65-Day Rule: The trustee can elect to treat distributions made within the first 65 days of the new tax year as having been made in the previous tax year. This can be advantageous when the trust is in a higher tax bracket than the beneficiaries, allowing the trustee to shift some of the trust’s income and tax liability to the beneficiaries, who may be in lower tax brackets. This election is made on the trust’s tax return (Form 1041).
• Income Distribution Deduction: When a trustee distributes income to beneficiaries, the trust can claim an income distribution deduction on its tax return. This deduction reduces the trust’s taxable income, which in turn reduces the amount of tax the trust has to pay. 

Important Notes:

• Consult a professional: Trust taxation is complex, and it’s essential to consult with a qualified tax professional or estate planning attorney to understand the specific tax implications of your situation and ensure compliance with tax laws.
• Trust document instructions: The terms of the trust document may specify how income is to be distributed, which can impact the tax responsibilities of both the trust and the beneficiaries. 

In summary, the successor trustee cannot elect to pay taxes at the individual rate of the trustee or a beneficiary for retained trust income. However, they can use strategic distributions and tools like the 65-day rule to potentially minimize the overall tax liability by shifting income to beneficiaries who may be in lower tax brackets.

IT IS POSSIBLE TO CREATE AN IRREVOCABLE ASSET PROTECTION TRUST, EITHER GRANTOR OR NON-GRANTOR, FILE IRS FORM 709 REPORTING THE GIFT TO THE IRREVOCABLE TRUST, THUS AVOIDING ESTATE TAX AND OBTAINING ASSET PROTECTION, AND STILL GET THE STEP UP IN COST BASIS TO THE DATE OF DEATH VALUE WHEN THE ASSET IS TRANSFERRED AT DEATH.

IT IS DONE THROUGH, EITHER THE GRANTOR OR NON-GRANTOR WHO FUNDED THE TRUST INTENTIONALLY RETAINING TAX LIABILITY.

The IRS has specific rules (found in Internal Revenue Code Sections 671, 673-678) that determine when a trust is considered a grantor trust. If the grantor retains certain powers or interests in an otherwise irrevocable trust, it may still be treated as a grantor trust for income tax purposes, meaning the grantor remains responsible for the income taxes on the trust’s earnings, regardless of the trust being irrevocable. 

Examples of irrevocable trusts treated as grantor trusts:

• Intentionally Defective Grantor Trusts (IDGTs): These are intentionally designed to be treated as grantor trusts for income tax purposes but as irrevocable trusts for gift and estate tax purposes. IDGTs can help transfer appreciating assets out of a grantor’s estate while the grantor pays the income tax on those assets.
• Grantor Retained Annuity Trusts (GRATs): The grantor transfers assets to the trust and receives an annuity payment for a set period. If structured correctly, this can effectively freeze the value of the assets for estate tax purposes

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