Tennessee Estate Planning: Cut Taxes with Irrevocable Trusts

Why Irrevocable Trusts Matter in Tennessee

Tennessee residents often use irrevocable trusts to separate certain assets from taxable estates, protect beneficiaries, and provide long-term management. Tennessee does not currently impose a state inheritance or estate tax (Tennessee Department of Revenue), but federal transfer tax rules may still affect larger estates. An irrevocable trust can position assets outside your taxable estate if properly structured and administered, potentially lowering federal estate tax exposure and enhancing creditor protection under applicable law.

How Irrevocable Trusts Reduce Tax Exposure

When you make a completed gift to an irrevocable trust and relinquish control, the trust—not you—generally becomes the owner of those assets. If designed and administered to avoid retained rights or powers that trigger federal estate inclusion, future appreciation can occur outside your taxable estate (see 26 U.S.C. § 2036 and § 2038). You may also use lifetime gift strategies to move future growth out of your estate.

In some designs, you can continue to pay the trust’s income taxes personally as the grantor, allowing trust assets to grow without erosion from income tax and indirectly benefiting beneficiaries (see 26 U.S.C. § 671 et seq.). Specific outcomes depend on careful drafting, the assets involved, and consistent administration.

Common Irrevocable Trust Options

• Irrevocable Life Insurance Trust (ILIT): The trust owns the policy so death benefits are kept out of your taxable estate if structured to avoid incidents of ownership (26 U.S.C. § 2042).
• Spousal Lifetime Access Trust (SLAT): One spouse makes a completed gift for the other spouse’s benefit while removing assets from the donor’s estate. Careful drafting is required to avoid the reciprocal trust doctrine and unintended inclusion risks.
• Charitable Remainder or Lead Trusts: Combine philanthropy with tax-efficient wealth transfers and potential income or gift/estate tax advantages.
• Grantor Retained Annuity Trust (GRAT): Seeks to shift asset appreciation to beneficiaries at a reduced transfer-tax cost (special valuation rules under 26 U.S.C. § 2702).
• Domestic Asset Protection Trust (DAPT): Tennessee recognizes self-settled spendthrift trusts when statutory requirements are met (Tenn. Code Ann. Title 35, Chapter 16).

Tennessee’s Domestic Asset Protection Trusts (TAPTs)

Tennessee authorizes self-settled spendthrift trusts if statutory conditions are satisfied, including a qualified Tennessee trustee and required formalities (Tenn. Code Ann. Title 35, Chapter 16). Properly implemented, a Tennessee asset protection trust can help shield assets from certain future creditor claims. Attention to solvency, funding sources, and timing is critical, and transfers remain subject to the Tennessee Uniform Voidable Transactions Act (Tenn. Code Ann. § 66-3-301 et seq.) and, in bankruptcy contexts, the federal look-back for certain self-settled trusts (11 U.S.C. § 548).

Funding Strategies and Formalities

• Align assets with trust goals: Consider marketable securities, life insurance, business interests, and income-producing real estate.
• Observe gift formalities: Use precise assignment and title-transfer documents; follow up with insurers, banks, and registrars.
• Administer correctly: Keep trust records, separate accounts, and consistent distributions. For ILITs, coordinate premium gifts and beneficiary notices.
• Coordinate with beneficiary designations: Update beneficiary and pay-on-death designations to avoid conflicts.

Income Tax Considerations

Many irrevocable trusts are taxed as separate entities with compressed brackets. Grantor trust provisions can shift the income-tax burden to the grantor, allowing trust assets to grow. Planning should weigh grantor vs. non-grantor status, potential basis step-up implications, state-level income-tax effects, and distribution strategies that manage distributable net income.

Creditor Protection and Compliance

Creditor protection depends on meeting Tennessee statutory requirements and avoiding transfers made with intent to hinder, delay, or defraud creditors. Funding should be done when you are solvent and without pending creditor issues. Trustees must follow fiduciary duties, keep records, and act in beneficiaries’ best interests as set out in the trust instrument and applicable Tennessee law.

When an Irrevocable Trust May Not Fit

Irrevocable trusts reduce personal control over assets and can be costly to maintain. They introduce complexity in tax reporting and investment management. If you need unfettered access to the assets, or if your estate is unlikely to face federal estate tax exposure, simpler strategies may be more appropriate.

FAQ

Does Tennessee have an estate or inheritance tax?

No. Tennessee does not currently impose a state estate or inheritance tax. Larger estates may still face federal estate tax.

Can I change an irrevocable trust later?

Changes are limited. Tennessee decanting or nonjudicial settlement agreements may allow targeted updates, but you generally cannot retain powers that cause estate inclusion.

Will an ILIT keep life insurance out of my estate?

Yes, if structured to avoid incidents of ownership and funded and administered correctly, policy proceeds are generally excluded from your taxable estate.

Are Tennessee asset protection trusts bulletproof?

No. They must meet statutory requirements and timing rules and remain subject to voidable transfer and bankruptcy laws.

Next Steps

Ready to plan? Schedule a consultation with our Tennessee estate planning team.

Disclaimer: This article focuses on Tennessee law and U.S. federal tax law. It is for general informational purposes only and is not legal, tax, or financial advice. Reading it does not create an attorney-client relationship. Laws change and outcomes depend on specific facts; consult qualified Tennessee counsel and your tax advisor. Asset-protection outcomes vary and may be affected by voidable transfer laws, bankruptcy law, and other states’ laws.