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- Estate Planning Basics
- Fundamental questions
- Will or living trust?
- Other facts about estate settlement
- Determining potential estate taxes
- Estate Tax Saving Strategies
- The marital deduction
- Life Insurance
- Annual gifting
- Charitable contributions
- Strategies for family-owned businesses
- Special strategies for special situations
- Community property issues
- Implementing and Updating Your Plan
- Where do you go from here?
- Estate planning worksheet
- Planning Levels Fee Schedule
THE MARITAL DEDUCTION
The marital deduction is one of the most powerful estate planning tools. Any assets passing to a surviving spouse pass tax free at the time the first spouse dies, as long as the surviving spouse is a U.S. citizen. Therefore, if you and your spouse are willing to pass all of your assets to the survivor, no federal estate tax will be due on the first spouse’s death — even before the estate tax is repealed.
But this doesn’t solve your estate tax problem. First, if the surviving spouse does not remarry, that spouse will not be able to take advantage of the marital deduction when he or she dies. Thus, the assets transferred from the first spouse could be subject to tax in the survivor’s estate, depending on when the surviving spouse dies. Second, from a personal perspective, you may not want your spouse to pass all assets to a second spouse even if it would save estate taxes.
Preserve both exemptions with a credit shelter trust
Since assets in an estate equal to the exemption amount are exempt from estate taxes, a married couple can use their exemptions to avoid tax on up to double the exemption amount. And this amount will gradually increase until it reaches $7 million in 2009 — the year before the estate tax repeal. (See Chart 1 on page 8.) An effective way to maximize the advantages of the exemption is to use a credit shelter trust.
Let’s look at an example: As shown in Chart 2, left column, Mr. and Mrs. Jones have a combined estate of $4 million. At Mr. Jones’ death in 2006, all of his assets pass to Mrs. Jones — tax free because of the marital deduction. Mr. Jones’ taxable estate is zero. Shortly thereafter, and still in 2006, Mrs. Jones dies, leaving a $4 million estate. The first $2 million is exempt from estate tax, but the remaining $2 million is subject to $920,000 in taxes, leaving $3,080,000 for the children.
The problem? Mr. and Mrs. Jones took advantage of the exemption in only one estate.
Let’s look at an alternative: As shown in Chart 2, right column, Mr. Jones’ will provides that assets equal to the exemption go into a separate trust on his death. This “credit shelter trust” provides income to Mrs. Jones during her lifetime. She also can receive principal payments if she needs them to maintain her lifestyle. Because of the trust language, Mr. Jones may allocate $2 million, his exemption amount, to the trust to protect it from estate taxes. If there were remaining assets (assets over $2 million), they would pass directly to Mrs. Jones.
Because the $2 million trust is not included in Mrs. Jones’ estate, her taxable estate drops from $4 million to $2 million. Thus, the tax at her death is eliminated, as both spouses’ exemptions are used. By using the credit shelter trust in Mr. Jones’ estate, the Joneses save $920,000 in federal estate taxes.
The Joneses do give up something for this tax advantage. Mrs. Jones doesn’t have unlimited access to the funds in the credit shelter trust because, if she did, the trust would be includible in her estate. Still, Mr. Jones can give her all of the trust income and any principal she needs to maintain her lifestyle. And the family comes out ahead by $920,000. But the outcome would be quite different if both spouses didn’t hold enough assets in their own names. (See Case study I.)
| Chart 2 How to reduce estate taxes with a credit shelter trust* |
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| * Based on 2006 exemption and tax rates. Chart doesn’t take into account any state estate taxes. Source: U.S. Internal Revenue Code |
- Case Study I
- Splitting Assets Without Splitting Up The Marriage
Does it matter which spouse dies first? Maybe. Let’s go back to our friends, the Joneses. Assume Mr. Jones owns $3.5 million of assets under his name and Mrs. Jones has $500,000 under her name. If Mr. Jones dies first, the credit shelter trust can be funded with $2 million from his assets. But if Mrs. Jones dies first, only the $500,000 under her name would be available to fund the trust. Mrs. Jones’ estate can take advantage of only $500,000 of her $2 million exemption amount.
To take maximum advantage of the credit shelter trust strategy, be sure property in each estate totals at least the exemption amount. Ensuring each spouse has enough assets may require reviewing how your assets are currently titled and shifting ownership of some assets. Even if you can’t perfectly divide assets, any assets owned up to the lifetime exemption limit will reduce the total tax.
A warning here is appropriate: Assets can be retitled between spouses without any negative federal tax effect, but some states treat transfers between spouses as taxable gifts for state tax purposes. Seek professional advice before transferring titles.
Control assets with a QTIP trust
A common estate planning concern is that assets left to a spouse will eventually be distributed in a manner against the original owner’s wishes. For instance, you may want stock in your business to pass only to the child active in the business, but your spouse may feel it should be distributed to all the children. Or you may want to ensure that after your spouse’s death the assets will go to your children from a prior marriage.
You can avoid such concerns by structuring your estate plan so your assets pass into a qualified terminable interest property (QTIP) trust. The QTIP trust allows you to provide your surviving spouse with income from the trust for the remainder of his or her lifetime. You also can provide your spouse with as little or as much access to the trust’s principal as you choose. On your spouse’s death, the remaining QTIP trust assets pass as the trust indicates.
Thus, you can provide support for your spouse during his or her lifetime but retain control of what happens to the estate after your spouse’s death. Because of the marital deduction, no estate taxes are paid on your death. But if your spouse dies while the estate tax is in effect, the entire value of the QTIP trust will be subject to estate tax.