Income Tax Advantages/Disadvantages to Revocable Trust (Con’t)

In my previous entry, I indicated that there are, as a general rule, no income tax disadvantages to holding property in a revocable trust. Prior to that, I indicated that a revocable trust does not offer any income tax advantages.

Notwithstanding the above, there is at least one situation that Kansas City estate planning attorneys (as well as other estate planners) should be familiar with in order to avoid causing an inadvertent tax result. This trap for the unwary is titling stock of a closely held corporation in the name of the revocable trust. Under §1244 of the Internal Revenue Code, ordinary loss treatment is available upon a sale or exchange (including a deemed sale when the stock becomes worthless) for shareholders who satisfy the requirements of that Code section. Trusts are not eligible shareholders for purposes of §1244.  Unfortunately, the language of §1244 stock is broad and neither the Code nor the regulations exclude revocable trusts from its ambit.

While policy reasons would suggest that revocable trusts should not be treated the same way as irrevocable trusts under §1244, the plain language of the statute and the regulations will make it difficult to argue that §1244 ordinary loss treatment is available for stock held in a revocable trust.

For titling purposes, the stock can be held in the name of the individual with a transfer on death designation to the trustee of the revocable trust (which will become irrevocable on the death of the grantor). If §1244 loss treatment is not a major consideration (e.g., the taxpayer has a low-basis in the stock which has significantly appreciated) then the stock can be titled in the name of the trust as the likelihood of loss upon a sale is quite small. In this latter case, the lifetime advantages of placing the stock in the trust will likely outweigh the §1244 considerations.

If tax advantages are top of mind, our attorneys can help you explore the best options for your estate plan. Contact our office through the form below.

 *This post was originally published on October 9, 2011