AN EXEMPTION TRUST?
An exemption trust is known by many names, including bypass trust, credit
shelter trust, or B trust. Regardless of the name of the trust, its purpose is
to reduce or eliminate federal estate taxes for a married couple's estate.
This type of estate plan sets up an irrevocable trust that will hold the
assets of the first spouse to die. The amount transferred to the irrevocable
trust usually will not be taxed for federal estate tax purposes when the second spouse
WHY SHOULD YOU USE
AN EXEMPTION TRUST? If your estate is greater than $5.25 million, and
you are married, an exemption trust could reduce the tax liability of your
estate, or eliminate it entirely.
DOES IT WORK? Let's look at how the
estate of a married couple would be taxed if the couple did not have an
exemption trust and the exclusion amount is $5.25 million in 2013:
Assume that a married
couple owns $10 million in community property and the couple has no estate
plan. On the death of the first spouse in 2013, that spouse's assets will be transferred to the surviving
spouse in accordance with the intestate succession laws. Regardless
of the amount that is transferred, there will be no federal estate
tax imposed at this point. Federal law allows the "marital
deduction" to be used when assets are transferred to the
surviving spouse, and that deduction eliminates any tax that
might otherwise be due. However, it also eliminates use of the
exemption for the first spouse to die because he or she had no
estate remaining that can be exempted from the tax.
As a result of the death of the first spouse, the surviving spouse
now owns the entire $10 million estate, but there is only one
$5.25 million exemption available because the marital deduction
was used to transfer the entire estate of the first spouse to
the surviving spouse. If the surviving spouse dies during 2013
with an estate of $10 million, a tax of about $1.9 million will
be due from his or her estate.
Assume that a married
couple with a net worth of $10 million has set up a living trust
that includes an exemption trust. While both of them are alive,
the assets will be held in the revocable living trust. On the
death of either one of them, the trust will be split into two
trusts: The survivor's trust, and the exemption trust.
In this example, the deceased spouse's share of the estate,
$5 million, will be transferred to the exemption trust. The "marital
deduction" will not be used because there are no assets that are transferred
to the surviving spouse. (The exemption trust and the surviving spouse are two
separate taxpayers for this purpose, even though the surviving spouse will
receive the income from the exemption trust and may spend the principal of the
trust in certain limited circumstances.) As a result, the exemption amount for
the first spouse to die is not lost because his or her assets were transferred
to a taxpayer other than the surviving spouse. Although this may seem like a
minor difference in the estate plan, establishing the irrevocable trust will
save the couple's estate approximately $1.9 million. If the surviving spouse
dies with an estate that is not valued at more than the exemption amount
that is allowed in the year of death, the surviving
spouse's estate will pay no federal estate tax.
OTHER OPTIONS TO
AVOID THE ESTATE TAX: A disclaimer
trust can also be used instead of an exemption trust. The surviving
spouse can decide whether to exercise his or her disclaimer rights, which will
reduce the amount of the estate subject to the estate tax. For more
information about the estate tax, see the