Revocable gift

What Is Revocable Gift?

A revocable gift is a transfer of assets where the donor retains the legal right to take back the gifted property at any time before a specified event, such as the donor's death. Unlike an outright donation, a revocable gift does not involve a complete relinquishment of control by the grantor (giver) over the property. This type of arrangement falls under the broader category of estate planning and financial planning, as it impacts how assets are managed and distributed during a person's lifetime and after death. The ability to revoke distinguishes this gift, offering flexibility that other forms of asset transfer may not provide.

History and Origin

The concept of gifting has ancient roots, but the formal regulation and taxation of gifts, particularly in the context of revocability, evolved with the development of modern property and tax law. In the United States, federal gift tax legislation was introduced with the Revenue Act of 1924, though it was repealed in 1926. It was reinstituted with the Gift Tax Act of 1932 to prevent individuals from avoiding estate taxes by transferring wealth during their lifetime.¹³, ¹⁴ The distinctions between revocable and irrevocable transfers became crucial in determining tax liability and ownership, influencing how gifts are legally structured.

Key Takeaways

• A revocable gift allows the donor to reclaim the gifted property at any time.
• The donor retains control over the asset, meaning the transfer is not complete for tax or legal purposes until the power to revoke is terminated or the donor passes away.
• Such gifts do not typically remove assets from the donor's taxable estate immediately.
• They can offer flexibility in financial and estate planning, allowing for changes if circumstances or intentions shift.
• The act of giving a revocable gift usually does not trigger immediate gift tax liability for the donor.

Interpreting the Revocable Gift

When a property is transferred as a revocable gift, it implies that the donor has not fully surrendered ownership. This means the asset continues to be considered part of the donor's personal wealth and estate. For instance, if the gift is made via a trust instrument, the terms of the trust explicitly state the grantor's retained right to alter, amend, or terminate the trust and reclaim the assets. This retention of control has significant tax implications, particularly regarding income tax generated by the gifted asset and its inclusion in the donor's estate for estate tax purposes. The value of a revocable gift is typically assessed at its fair market value at the time of the gift, but its treatment in the context of estate and gift taxes depends on the donor's retained control.

Hypothetical Example

Consider Sarah, a 75-year-old widow who wants to help her grandson, Tom, purchase his first home but also wants to ensure she retains access to her funds if her financial needs change unexpectedly. She establishes a special bank account for Tom, depositing $100,000, but sets up the account so that she remains a co-owner with the right to withdraw funds at any time.

In this scenario, Sarah has made a revocable gift. While Tom has access to the funds, Sarah retains full control. If Sarah's health declines and she needs significant funds for medical care, she can withdraw the entire $100,000 from the account. This arrangement allows her to provide potential assistance to her beneficiary without fully committing the assets, offering flexibility for her own future needs. If Sarah were to pass away with funds remaining in the account, these funds would generally become an outright gift to Tom, subject to her will or the account's transfer-on-death provisions, and would be included in her estate for estate tax calculations.

Practical Applications

Revocable gifts are often employed in various personal and succession planning strategies. A common application is through a revocable living trust, where the grantor transfers assets into the trust but retains the power to revoke or amend it during their lifetime. This allows for seamless asset management, avoidance of probate upon the grantor's death, and flexibility in designating a beneficiary while the grantor is alive.

Another practical area where the concept of revocability is critical is in qualifying for certain public benefits, such as Medicaid. Governments often have "look-back" periods for asset transfers made for less than fair market value. For instance, Medicaid has a five-year look-back period for asset transfers, and if a gift is made within this period, it could result in a penalty period during which the individual is ineligible for benefits.¹¹, ¹² While outright gifts are scrutinized, any gift where the donor retains control, making it revocable, generally means the asset is still counted for eligibility purposes, as the transfer is not considered complete.⁹, ¹⁰

Limitations and Criticisms

Despite their flexibility, revocable gifts have significant limitations, primarily concerning asset protection and tax planning. Since the donor retains control, the assets transferred via a revocable gift are generally not protected from creditors, lawsuits, or inclusion in the donor's estate for estate tax purposes. The Internal Revenue Service (IRS) clarifies that the donor is generally responsible for paying any applicable gift tax.⁷, ⁸ This means that while no immediate gift tax may be due upon the creation of a revocable gift, the assets typically remain part of the donor's taxable estate upon their death. This lack of a definitive transfer means they do not achieve the tax-saving or creditor-protection benefits that an irrevocable gift might offer. Critics highlight that while the flexibility is attractive, it comes at the cost of potential estate tax burdens and lack of asset protection.⁶

Revocable Gift vs. Irrevocable Gift

The fundamental distinction between a revocable gift and an Irrevocable gift lies in the donor's retained control over the gifted property.

While a revocable gift prioritizes flexibility, an irrevocable gift prioritizes definitive transfer, often for tax benefits or asset protection purposes. Understanding the implications of each is crucial for effective financial planning.³

FAQs

Can a revocable gift become irrevocable?

Yes, a revocable gift can become irrevocable. This typically happens upon the death of the donor, at which point the donor's ability to revoke the gift ceases, and the gift becomes complete. Alternatively, the donor might formally renounce their right to revoke during their lifetime, converting the gift to an irrevocable one.

Are revocable gifts subject to gift tax?

Generally, a revocable gift is not considered a completed gift for gift tax purposes at the time it is made, because the donor retains control. Therefore, no immediate gift tax is typically due. However, the assets remain part of the donor's estate and may be subject to estate tax upon their death.¹, ²

Do revocable gifts avoid probate?

Some forms of revocable gifts, such as those made through a revocable living trust, are designed to avoid probate. Assets held within a properly funded revocable trust pass directly to the designated beneficiary upon the grantor's death, bypassing the probate court process. However, if the gift is not structured within such a vehicle (e.g., a joint bank account without specific transfer-on-death instructions), it may still go through probate.

Who is responsible for managing the assets in a revocable gift?

Typically, the donor (or grantor) retains full control and management over the assets in a revocable gift, particularly if it's a revocable living trust where the donor often serves as the initial trustee. The executor or successor trustee would take over management only if the donor becomes incapacitated or passes away.