Tax Planning Trusts

There are many different types of trusts that can be used for estate planning purposes and what follows is a basic description of a few of the more popular ones. In addition to reducing (or perhaps eliminating) estate taxes, these trusts also serve as a method to avoid the probate process. Probate can be an expensive and drawn-out process that may take six months to a year to settle and distribute an estate. Using these trusts can help to speed this process considerably and at a greatly reduced cost. You should consult an attorney to discuss you specific situation prior to relying on the information included below.

There is currently some uncertainty as to what, if any, estate taxes are owed on estates for people who pass away in 2010. Effective January 1, 2010, the federal estate tax was repealed--in other words, someone who passes away in 2010 (assuming the law is not changed) can leave an estate of any size to his or her heirs without being subjected to estate tax. However, effective January 1, 2011, the estate tax will return with a vengeance--estates greater than $1 million will be subject to the tax. There are a few ideas working through Congress, but until something is enacted, there will continue to be uncertainty in this area. Effective estate plans should address this uncertainty within the Declaration of Trust to plan for these future changes in the estate tax. The discussion below assumes that no changes are made by Congress and estates greater than $1 million will be subject to the tax.

A/B Trusts

An A/B trust is a method for married clients to use both the husband and wife's $1 million exemption--essentially, giving the couple a combined $2 million exemption. The trust is created when both husband and wife are still alive; when the first of them passes away, the estate is divided into two portions, an "A" and a "B" side of the trust. Assets are split between the two trusts--assets placed in the "A" trust (decedent's trust) are in an irrevocable trust that will pay income to the "B" trust (survivor's trust) for the life of the surviving spouse. When structured this way, the surviving spouse only owns (for the Internal Revenue Service's purposes) the income from the deceased spouse's trust--thus, the assets in the "A" trust are not included in the surviving spouse's estate. When the surviving spouse passes away, both sides of the trust are distributed to the ultimate beneficiaries--half coming from the first spouse to die, and the remaining half from the second spouse to die.

How Will This Help Reduce Estate Taxes?

Imagine a couple whose assets are worth $2,000,000 (including all bank accounts, real estate holdings, stock portfolios, etc...). If they do not have a tax-saving estate plan in place, the first to die usually leaves everything to the surviving spouse--no estate tax would be due at that point. However, when the second spouse passes away (assuming current law remains in effect after 2011), the $2,000,000 estate would owe a 45% estate tax on assets exceeding $1,000,000 (or, in another words, a $450,000 death tax!).

If the same couple were to have a tax-saving estate plan in place--after the first spouse dies, one-half ($1,000,000) of their combined assets are placed in an irrevocable living trust. The surviving spouse receives the income from the assets in irrevocable trust. When the second spouse passes away, both halves of their combined estates are distributed per the instructions they made in the trust--but because neither "side" of the trust passed along more than $1,000,000, there is no estate tax due, saving $450,000!

QTIP Trusts

A QTIP (Qualified Terminable Interest Property) Trust is similar to an A/B Trust, but limits the surviving spouse's access and control of the irrevocable trust property. QTIP's are frequently used when there are concerns about: a surviving spouse remarrying and benefiting the new spouse; the surviving spouse benefiting someone other than the beneficiaries you had previously agreed on; a surviving spouse's creditors attaching the trust property; or when there is separate property from a previous marriage that is not to be included in the estate of the surviving spouse.

A QTIP Trust can be an effective estate planning technique; however, it can be complicated to administer and the QTIP election must be made on time and in consideration of all the circumstances existing at the time of death.

Life Insurance Trusts

An irrevocable life insurance trust is a method of reducing the estate prior to death in order to minimize the effect a life insurance payment would have on taxes owed by your estate. For example, if you were to have a life insurance policy that would cause your estate to be subject to the estate tax, this method will usually avoid including the insurance policy when the value of your estate is calculated. This is accomplished when an irrevocable life insurance trust is created by the client to be managed by a trustee and with beneficiaries that the client selects. The trust owns the life insurance policy which is funded by annual gifts from the client. When the client eventually passes away, the insurance policy may avoid probate (and estate taxes) to be distributed directly to the beneficiaries of the life insurance trust.

These are a few of the different estate planning options that are available to reduce estate taxes. There are other, more complicated, options available that may also be appropriate depending on the anticipated size of your estate.

Important

This information is not to be construed as legal advice; you should consult an attorney about your specific issue before relying on anything discussed on this website. If you are looking for advice about your specific legal issue, I offer all prospective clients a free initial consultation and my services are available on either an hourly or flat-rate basis and at reasonable prices. Please feel free to contact me if you have any questions--my contact information is available here.

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