High net wealth individuals frequently use trust structures in their estate planning to avoid the complications of probate for their loved ones after they pass. Trusts also offer a strategic advantage in addressing estate and gift tax issues. Knowing the essential differences between trust structures and understanding your estate and gift tax exposure are crucial for maximizing the benefits of trusts in your tax and estate planning.
The Revocable Trust vs. the Irrevocable Trust
In a revocable trust, the settlor retains control over the trust assets and can change the terms or beneficiaries as they see fit. “Revoking” is the act of a settlor taking back assets from the trust in some way, so when the settlor dies (and cannot take the assets back), these trusts typically become irrevocable.
In an irrevocable trust, the settlor relinquishes control over all assets transferred to the trust from the start, and cannot change the trust terms. Because these transfers cause the settlor to lose control of the assets, the law generally requires the trust agreement to explicitly say that the trust is irrevocable.
Most people use revocable trusts to avoid probate – the costly and time-consuming process of transferring assets from a deceased person to the people who will receive from them. So, if a revocable trust retains flexibility and avoids probate, why bother setting up an irrevocable trust? The answer is gifting.
The U.S. has a unified tax on assets gifted during life or transferred at death. Only the wealthiest pay this tax, so gifts are excluded from this tax up to a certain limit – the estate tax threshold. Revocable trusts do nothing to reduce estate tax liability for large estates. Conversely, gifting provides the tax benefit to irrevocable trusts because these trusts are treated as separate taxpayers (if done correctly).
The Only Time Freezing in Texas is a Good Thing
We had a thoughtful client who came to us, certain that some assets would grow in value over time, even while the client was below the 2025 estate tax threshold. The client proposed to gift to a trust which does not die or pay estate tax. But for this to work, the gift needs to be a “completed gift.”
If the donor retains control over the property, the gift is not complete. Consequently, gifts to revocable trusts are incomplete because the donor can alter, amend, or revoke any gift to the trust. These gifts are not considered complete until the trust becomes irrevocable, which typically occurs upon the donor’s death or another specified event.
Therefore, a completed gift is one where the donor relinquishes all control over the gifted property. The donor must intend to and actually divest themselves of all title, dominion, and control over the property, making the transfer absolute and irrevocable. In light of this, we advised against the client withholding any possession or enjoyment of a trust estate holding those assets, which would have made the transfer is subject to estate tax. This is because the transfer is considered to take effect in possession or enjoyment after the grantor’s death, meaning the gift wasn’t completed, resulting in a negative tax consequence, and the principle is well underlined in cases going all the way back to 1940.[1]
Courts do agree that completed gifts avoid estate tax on appreciation after the gift is completed. And we’ve advised on this many times in the past, so we were ready to advise the client to execute an estate plan where client transferred shares to a family limited partnership (FLP) and received a partnership interest equal to client’s contribution. This transfer effectively froze the value of the shares (and underlying assets) for estate tax purposes, allowing future appreciation to benefit client’s children, who would later become limited partners.[2] The benefit cannot be understated: in a taxable estate, the power of gifting assets before they further accumulate value saves millions of dollars in estate tax decades ahead of schedule.
Conclusion
When setting up a trust, you should consider that revocable trusts provide greater control and the ability to amend terms during the settlor’s lifetime, but don’t provide much estate tax protection. Completed gifts to irrevocable trusts offer a critical advantage for wealth creators looking to reduce their taxable estate through gifting by freezing the value of assets and avoiding potential estate tax on future appreciation. If you have assets approaching the taxable thresholds, this structure may result in significant tax savings. Both revocable and irrevocable trusts avoid the costs and time of probate, but irrevocable trusts provide powerful tools to optimize estate planning and reduce tax exposure.
THIS POST IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE OR CONTAIN TAX OR LEGAL ADVICE.
[1] Bethea v. Sheppard, 143 S.W.2d 997, 998 (Tex. Civ. App. 1940), writ ref’d.
[2] This structure is supported in cases like Dutcher v. Dutcher-Phipps Crane & Rigging, Inc., 510 S.W.3d 592, 594 (Tex. App. 2016)
