Irrevocable trusts, such as Irrevocable Life Insurance Trusts (ILITs), Charitable Remainder Trusts (CRTs), and Qualified Personal Residence Trusts (QPRTs), are generally used to remove assets from a grantor’s estate, potentially exempting them from federal estate and inheritance taxes. These structures work because the grantor relinquishes ownership and control, meaning assets are not considered part of the taxable estate upon death.
Bare trusts
Transfers into a bare trust may also be exempt from Inheritance Tax, as long as the person making the transfer survives for 7 years after making the transfer.
If you receive principal (the original assets placed in the trust), generally it's not taxable. If you receive income generated by the original assets (like interest, dividends, or rent) and it is reported on Schedule K-1, it is taxable to you and must be reported on your return using the Schedule K-1 from the trust.
Exemption trusts (also called a bypass trust, AB trust, or a credit shelter trust) are a tool used by well-off married individuals to legally maximize their estate tax exemptions. The strategy involves creating a trust or two separate trusts after one spouse passes.
While few trusts are entirely tax-exempt, certain types, like Charitable Remainder Trusts, GST-Exempt Trusts, and specific Special Needs Trusts, receive significant tax advantages or exemptions, often by passing income to tax-exempt entities or individuals, or by meeting specific IRS criteria for estate tax avoidance (like Bypass Trusts) or generation-skipping tax (GST) relief. Most trusts still pay some tax, but benefit from deductions or exemptions (e.g., $100 or $300 for basic trusts).
Charity exemption
Like the spousal exemption, assets passing to charity on death are exempt from inheritance tax. As such, if an entire estate passes to charity, there will be no inheritance tax due.
Trusts also offer tax advantages, allowing assets to pass to future generations with minimal estate taxes. Most importantly, they provide lasting protection and guidance, so your gift supports your loved ones for decades—or even centuries. Planning ahead means your legacy stays secure, no matter what life brings.
Making a will to distribute your assets
Whether leaving assets to a spouse or civil partner, distributing assets to take advantage of tax-free allowances, or making gifts to charity, a valid will could help you to reduce or avoid Inheritance Tax altogether.
Even so, for estate tax purposes, the assets in an irrevocable grantor trust may be considered outside of the grantor's estate and therefore not subject to estate taxes at the grantor's death.
If you put things into a trust, provided certain conditions are met, they no longer belong to you. This means that when you die their value normally won't be counted when your Inheritance Tax bill is worked out.
If you die within 7 years of making a transfer into a trust your estate will have to pay Inheritance Tax at the full amount of 40%. This is instead of the reduced amount of 20% which is payable when the payment is made during your lifetime.
An irrevocable trust transfers asset ownership from the original owner to the trust, with assets eventually distributed to the beneficiaries. Because those assets don't legally belong to the person who set up the trust, they aren't subject to estate or inheritance taxes when that person passes away.
Fortunately, in California, there is neither an estate nor an inheritance tax, and the federal estate tax clicks in only if the value of the estate surpasses $12.92 million in 2023 (it rises each year according to inflation). The IRS likewise does not treat your inheritance as income.
Gifting, both one-off lump sums, and regular gifts out of income, or life assurance are several options for mitigating your IHT liability and reducing your IHT tax bill. Starting your IHT planning early and taking financial advice can have a direct impact on your family's financial wellbeing after you're gone.
Pensions. Pension funds passing on death to a spouse or civil partner incur no Inheritance Tax.
While few trusts are entirely tax-exempt, certain types, like Charitable Remainder Trusts, GST-Exempt Trusts, and specific Special Needs Trusts, receive significant tax advantages or exemptions, often by passing income to tax-exempt entities or individuals, or by meeting specific IRS criteria for estate tax avoidance (like Bypass Trusts) or generation-skipping tax (GST) relief. Most trusts still pay some tax, but benefit from deductions or exemptions (e.g., $100 or $300 for basic trusts).
The crackdown has resulted in the ATO undertaking extensive audits of family trusts and historical distributions, and the issue of hefty Family Trust Distributions Tax (FTD Tax) assessments for noncompliance – being a 47% tax (plus Medicare levy) along with General Interest Charges (GIC) on any historical liabilities.
The strongest type of trust, especially for asset protection and tax benefits, is an irrevocable trust, particularly one established in a favorable jurisdiction (like an offshore trust) or a Dynasty Trust, as these remove assets from your control and estate, shielding them from creditors, lawsuits, and estate taxes, though they sacrifice flexibility for permanence. For relational trust, it's about deep vulnerability and reliability, not a specific legal type.