Irrevocable Trusts & ILITs

A trust whose terms the settlor cannot change and whose property the settlor cannot take back. The permanence is what moves the property out of the taxable estate: sections 2036 and 2038 pull back any transfer in which the settlor keeps the income, the power to decide who benefits or the power to revoke. A settlor may still keep a power to swap assets of equal value, which makes the trust a grantor trust for income tax and lets low-basis assets be exchanged out before death, and may keep the power to replace the trustee with an independent one. Gifts to the trust above the annual exclusion are reported on Form 709 and use lifetime exemption, which is $15 million per person in 2026. Illinois allows the terms to be adjusted later by nonjudicial settlement agreement or by decanting, within limits that preserve the tax result.

An irrevocable trust formed to own life insurance on the settlor. The trustee applies for the policy, is named its owner and beneficiary, and pays the premiums from a trust account funded by the settlor's gifts. Because the insured never holds an incident of ownership, the death benefit is not in the insured's estate under section 2042, and because the trustee rather than the insured was the applicant, the three-year look-back of section 2035 never starts. Each premium gift is followed by Crummey notices giving the beneficiaries a short right to withdraw, which qualifies the gift for the $19,000 annual exclusion. At death the carrier pays the trust, and the trust holds or distributes the proceeds under terms fixed years earlier, often buying assets from the estate so the tax can be paid without a sale.

By a completed gift the settlor cannot undo. The gross estate includes property the decedent owned at death plus property the decedent transferred while keeping a string: the income or use of it, the power to decide who gets it or the power to alter or revoke the transfer. Cut every string and the property, and all its later growth, is outside the estate. Two timing rules remain. A power released within three years of death is treated as still held, and a life insurance policy transferred within three years is counted in full. The gift uses exemption at the value on the date of the gift, so property expected to grow is given early, and the estate-tax saving is weighed against the basis step-up the heirs lose on property that leaves the estate.

Within limits, yes. Illinois lets the trustee and beneficiaries sign a nonjudicial settlement agreement on administrative matters such as trustee succession or accounting, and the Illinois Trust Code lets a trustee with discretion over distributions decant the assets into a new trust with updated terms. A trust protector, if the instrument names one, can be given power to amend administrative provisions, change situs or remove a trustee. What cannot be done without tax consequences is to shift who benefits: a beneficiary who agrees to give up an interest has made a gift, and a settlor who regains control has undone the estate-tax result. For an ILIT the practical alternative is often simpler, since the trustee can exchange the policy or let it lapse and a new trust can own the next one.

A gift to a trust is a gift of a future interest and does not qualify for the annual exclusion unless the beneficiary can take it now. Crummey notices create that present interest: after each premium gift the trustee writes to every beneficiary that the contribution may be withdrawn for a set period, usually thirty days, and pays the carrier only after the period runs. With the notices, a settlor can give each beneficiary $19,000 a year without using exemption, and often without filing a return. Without them, every premium is a taxable gift. A beneficiary who lets a right lapse over the greater of $5,000 or five percent of the trust has made a gift back, which a hanging-power clause defers. We supply the notice forms, the calendar and the trust bank account, since a premium the settlor pays to the carrier directly undoes the design.

As the liquid part of it. Federal estate tax is due nine months after death, Illinois estate tax on the same schedule, and an estate made up of a company and real estate has no way to pay either without a sale unless the ILIT can buy assets from the estate or lend to it. The trust is drafted with those powers, and the revocable trust is drafted to sell to it. The beneficiary designations, the will and the buy-sell agreement are then checked so that none of them routes insurance back through the estate by accident. Where an inclusion question is raised on examination, we have represented clients in matters before the IRS, and the file kept since the trust was signed is what answers it.