The Revocable Trust is a powerful estate planning tool. The flexibility that this type of instrument offers your family is tremendous, especially in Tennessee. But many people misunderstand the tax consequences of a Revocable Trust, both during life and after death.
We’re going to discuss some highlights about the tax treatment of Revocable Trusts, both during life and at death. Whether you’re creating a Trust or are a Trustee yourself, these basics can help you avoid tax surprises.
Income Tax Treatment for Revocable Trusts
The IRS treats a Revocable Trust as a “Grantor Trust” for federal income tax purposes. That means the IRS ignores the existence of the Trust while the Grantor (or Settlor) is alive.
All income and deductions flow through to the Settlor’s personal tax return. No separate EIN or a Trust tax return is necessary while the Trust remains revocable. The Settlor’s Social Security Number is the Trust’s tax identification number during his or her lifetime.
Let’s say you have a non-retirement investment account. Retitling the account to your Trust does not cause any realization of capital gains or change the reporting. You are still the owner for tax purposes. If you sell any stock after that, the gains or losses simply go to your tax return as if the Trust didn’t exist.
This makes administration of a Revocable Trust pretty simple while the Settlor is alive.
Gift Tax Implications
Like with income taxes, there are also no gift tax consequences when you transfer assets into a Revocable Trust. That’s because the Settlor retains full control of the Trust’s assets.
Since the Trust is still revocable, the IRS does not consider the transfer to be what’s called a completed gift. When someone fully relinquishes control over an asset to another person, that’s a completed gift for tax purposes.
If the amount of the gift to a non-spouse exceeds the annual exclusion ($19,000 in 2025), there is either gift tax due, or the donor must file a gift tax return to use some of the lifetime credit against estate and gift taxes.
But because the Settlor of a Revocable Trust can change any aspect of the Trust, including the distribution plan, there isn’t any giving up control of those assets.
Not to mention the fact that, most of the time, the Settlor will also serve as Trustee while living. But even if there is someone else serving as Trustee, if the Trust is revocable, there is no complete gift.
There is an important nuance for married couples creating a Joint Trust. These couples should retain the right to withdraw their respective contributions at any time without the consent of the other Settlor. Each may also retain what’s called a general power of appointment over their respective Trust shares.
Without these provisions, their contributions could be completed gifts. This could cause a loss of the step up in tax basis.
Estate Tax Inclusion of Assets in a Revocable Trust
Many people assume that assets in a Revocable Trust avoid estate tax. But that’s not true.
For federal estate tax purposes, assets in a Revocable Trust are in the Settlor’s gross estate under the tax code sections 2036 and 2038. This is so because the Settlor keeps control over the Trust’s assets and can revoke the Trust at any time.
Some provisions in a Revocable Trust can take advantage of available deductions from estate tax. But the existence of the Trust itself does not prevent imposition of estate tax on assets in the Trust.
Fortunately, few people are subject to the estate tax these days. The exemption level in 2025 is $13.99 million per person. In 2026, that exemption will go up to $15 million per person thanks to the passage of the “One Big Beautiful Bill Act.” The IRS will index this exemption amount for inflation starting in 2027.
Step Up in Basis at Death
One important tax benefit of a Revocable Trust is that it doesn’t interfere with the step up in basis at death.
When the Settlor dies, assets in the Trust generally receive a new cost basis equal to their fair market value on the date of death. This can eliminate capital gains tax on built-in appreciation for assets like real estate, businesses, and stocks.
Let’s say you own your primary residence and place it into your Trust. At your death, the house’s tax basis is adjusted up to the house’s fair market value. The step up applies regardless of whether the asset passes through probate or a Revocable Trust.
The step up applies to assets in a Revocable Trust because of what we discussed in the prior section. When an asset is in a person’s gross estate for tax purposes, that asset will generally get a step up in basis.
This can be a two-edged sword for those with taxable estates, as estate tax can be an issue. But that’s very few people these days.
Post-Death Tax Treatment for Revocable Trusts
After the Settlor of a Revocable Trust dies, the Trust becomes irrevocable. At this point, the Trust needs a new tax identification number. The new Trustee generally must file a tax return for the Trust each year of its existence after it becomes irrevocable.
A Revocable Trust that has become irrevocable is its own taxpayer. When it comes to filing Trust tax returns, tax brackets are compressed compared to individuals. The highest marginal rate of 37% starts at merely $15,650 of Trust income in 2025.
But, Trusts have what’s called a Distributable Net Income deduction. This allows the Trustee to distribute income to the Beneficiaries of the Trust and reduce what is taxable to the Trust. The Beneficiaries are then taxed on this amount based on their tax brackets, which are almost always lower than the Trust’s brackets.
Trust administration is more complex once the Trust is irrevocable. So it’s important for Successor Trustees to work with professionals who understand Trust accounting and fiduciary duties.
Closing Thoughts on Tax Consequences of Revocable Trusts
Trusts are an excellent vehicle to accomplish a variety of goals. Though they are not for everyone, many types of people can benefit from having a Trust, including small business owners and parents of minor children. We’ve written at length about Trusts in other articles on our Resources page.
Before setting up a Revocable Trust, you should understand the basics of the tax implications. Thankfully they are minimal during your lifetime. But things become much more complex once your Trust becomes irrevocable. Which is why who you choose to carry out your plan is almost as important as what you choose to do.
At Connell Law, PLLC, we help Tennessee families create and manage their Revocable Trusts with confidence. If you’re wondering whether a Revocable Trust is right for you, contact our office today to request a consultation.
