A very common question that I receive from many of my client setting up their estate legal affairs is whether they have to pay any taxes on assets that they intend on transferring to an irrevocable trust. For example, this couple from Nashville that I was speaking with wanted to set up an irrevocable trust in order to protect their assets and preserve their assets for their children from future nursing home expenses. Specifically, this couple wanted to preserve their Medicaid eligibility in the event that they went into a nursing home. However, this family was concerned about the tax consequences if they transfer all of their assets into the name of this irrevocable trust.
First, I asked this couple what type of taxes they are referring to because there are a lot of different types of taxes. I then said that if your question is about income taxes, then the answer is no. There are no income taxes due just because you transfer assets into the name of an irrevocable living trust. However, I told this couple that it sounded to me that you are referring to gift taxes, and that is somewhat of a complicated and two-part answer to your question.
I explained to this couple that the IRS allows you to give away up to $14,000 each year as of 2015 without any gift tax consequences and without having to file a gift tax return. However, if you give away more than $14,000 in a year, you are required to file a gift tax return with the IRS. Although, you should keep in mind that just because you make a gift in excess of $14,000 does not mean that you or the person who received the gift owes any taxes. What this does mean however is that your $5.4 million exemption from the federal estate tax at your death is reduced by the amount over the annual exclusion limit. For example, I explained to this couple that if you give away $24,000 to your son this year, then you have made a $10,000 taxable gift, and their exemption from the federal estate tax would be reduced from $5.4 million to $5.39 million. However, I explained to this couple that they will only owe taxes if they die with assets in their name in excess of $5.39 million.
I discussed with this couple that these gift tax consequences are not implicated if they transfer their assets into an irrevocable trust to preserve for Medicaid purposes. I explained to this couple that for the IRS to consider the transfer a gift for purposes of implicating gift tax consequences, the gift must have what is called a present interest. I told this couple that what I mean is that if the person they give the asset to must have a present interest in the gift and an ability to control the gift. I explained that since you are transferring these assets into a trust and you will continue to control your assets of the trust, then their surviving family members do not have a present interest in the gift, and therefore there would be no gift tax consequences.