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Can an Irrevocable Trust Be Liquidated?

The good news about an irrevocable trust is that you can't change it. That's also the bad news. An irrevocable trust is set up to hold specific assets of its creator, or grantor, to avoid costly court probate settlements and reduce taxes. A trustee controls all the assets given to the trust by its grantor. Trusts are created under state laws, so there are variations, but most follow the model of the Uniform Trust Code.

When Assets Are Distributed

Normally, you would not try to liquidate an irrevocable trust until the grantor has died and the trustee has disbursed all the trust assets. Once all money, property or other assets are distributed to specified beneficiaries under terms of the trust, the trustee can terminate the trust. That's the way most trust agreements are written.

If Situations Change

If there is good reason to liquidate the trust, such as the assets being insufficient to meet the dispositions, a trustee can ask a court to liquidate the trust. A grantor also can ask a court to liquidate the trust if he can show that situations have changed materially since the original trust was created or that the lawyer who drafted it erred in some way. Usually, a grantor must go through the trustee to file for such an order because trusts normally charge the trustee with handling all aspects of the trust.

By Agreement

Irrevocable trusts can be liquidated in many cases if the trustee and all the beneficiaries agree. This also will require a court action, initiated by the trustee. Guardians or other representatives of minors or beneficiaries who cannot handle their own affairs must consent. Beneficiaries often decide they would rather receive assets in a lump sum than continue to receive payments.

Start a New Trust

In some states, a grantor can liquidate an irrevocable trust by creating a new one and having the trustee transfer the assets to the new entity. A grantor may be able to do this to change some terms, like methods of distributing assets, so long as beneficiaries receive essentially the same distributions. This type of liquidation could, for example, provide for continuing distributions to children rather than lump sum payments.

Tax Implications

There will be tax considerations with any trust liquidation Beneficiaries usually will have no estate tax obligations unless the trust is very large, but the Internal Revenue Service considers liquidating a trust like closing a business and requires the filing of a return showing the disposition of all property and assets.