The Gift Tax Exclusion In An Irrevocable Trust

In 2017, the annual gift tax exclusion remains at $14,000. This means that each year, you can give $14,000 in cash, stocks and bonds, or an interest in physical property without triggering any gift tax. This $14,000 figure is indexed to inflation and therefore tends to rise modestly over time (e.g. back in 2000, you were permitted transfer $10,000 of present value without triggering a gift tax). The top rate thereafter is 40%. Also, the annual gift tax exclusion allows for separate gifts from two parents. In other words, a child may receive $14,000 from mom and $14,000 from dad for a total value of $28,000 each year without any required tax obligation.

You might wonder: What happens if a family is trying to build up an irrevocable trust fund for their three kids in a tax efficient manner? Should they give their kids $28,000 each, or is there a way to stockpile the $84,000 in a tax efficient manner in an irrevocable trust?

Well, they could give each kid $28,000 each year. The two drawbacks of this is that many kids of the affluent have developed a learned helplessness attitude towards wealth stewardship because their destiny has never required financial savviness. Also, even if the child is financially prudent, an irrevocable trust can offer tax benefits, centralization simplicity, and asset-shielding from creditors that make an irrevocable trust preferable to an outright gift.

From a compliance perspective, the catch is that money contributed towards an irrevocable trust is ordinarily considered a “future interest.” A future interest means that you don’t have immediate access to the benefit of the asset. With an irrevocable trust, the money is held and invested for the child’s future benefit. To qualify for the $14,000 gift tax exclusion, the gift must be a “present interest” that grants the beneficiary immediate access.

In nearly every state, there is a path to get each $14,000 contribution to an irrevocable trust to qualify for the annual gift tax exclusion.

To do this, the trust include language called a “withdrawal right” or “demand right.” Namely, at the time the $14,000 contribution is made to the irrevocable trust, the language must include a provision that states each beneficiary of the $14,000 must have the right to demand the $14,000 from the trust in the tax year that the $14,000 is added to the trust.

You wouldn’t want your beneficiaries to actually make this withdrawal, as it would eliminate the long-term compounding advantages of the strategy. So you would want to instruct your intended beneficiaries on why they shouldn’t exercise the right. Nevertheless, the entitlement to make the withdrawal must be written into the trust instrument in order for a $14,000 contribution to an irrevocable trust to count towards the annual gift tax exclusion. It is the capacity of the beneficiary to make the immediate demand to withdraw $14,000 that permits the contribution to count as a present rather than future interest.

These arcane tax rules may sound boring, but they can be critical for maximizing after-tax wealth. That $84,000 you can sneak into an irrevocable trust each year by attaching withdrawal powers to qualify for the annual gift tax exclusion can compound into $2 million for the three kids if it compounds at 8% annually for thirty years. And that is the result of a single year’s savvy use of the tax code.

Originally posted 2017-01-07 21:06:01.

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2 thoughts on “The Gift Tax Exclusion In An Irrevocable Trust

  1. says:

    One thing is clear – there are a lot of articles on this topic, but this one is the best. Others write non-interesting and dry, and read quickly and after reading there were no unnecessary questions to the author.

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