While some trusts do provide creditor protection against lawsuits brought by creditors, others do not. Generally, revocable living trusts are susceptible to these attacks. There are many reasons why this is the case.
Four Reasons Why Assets in a Revocable Living Trust Are Reachable by Creditors
When upholding the law, the courts seek fairness. If a person could place all of their assets into a revocable living trust, maintain full use and enjoyment over those assets, and then successfully use the trust to avoid valid creditor claims, that would be damaging to creditors. As a result, certain types of trusts will not stand up to a legal attack brought by a creditor in an attempt to reach trust assets. This concept usually applies to revocable living trusts. The following are four reasons why these trusts are not given creditor protection rights:
- Typically, the initial trustee of a revocable living trust is the grantor, creator, or settlor of the trust. This means that the person whose assets are going into the trust maintains control over those assets. Therefore, for legal purposes, the grantor is still treated as the owner of the trust’s assets.
- In most revocable living trusts, the creator of the trust keeps the ability to use, sell, move, and enjoy the assets that were placed inside the trust. As such, the law in California directs that the assets should be reachable by creditors since the trust does not change the asset owner’s use or rights relating to the property.
- Since a revocable trust can be terminated at any time, the court deems the assets to be reachable by creditors. When a trust is revoked, title of the assets reverts back to the creator of the trust.
- Even the Internal Revenue Service treats assets held in revocable living trusts as being held by the trust’s creator. Any income generated by these assets is taxed on the grantor’s personal income tax return. A revocable living trust is not treated as a separate tax paying entity while the grantor is living.
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