WHAT IS
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
dies.
HOW
DOES IT WORK? Let's
look at how the estate of a married couple would be taxed during 2009 if
the couple did not have an exemption trust: (The federal estate tax is currently in limbo
because Congress has not acted on a pending bill that would continue the $3.5
million exemption. If the bill is passed, the following discussion will
be relevant.)
EXAMPLE
1:
Assume that a married
couple owns $7,000,000 in community property and the couple has no estate
plan. On the death of the first spouse, 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 a "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 $7,000,000 estate, but there is only one
$3,500,000 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 2009
with an estate of $7,000,000, a tax of about $1,500,000 will
be due from his or her estate.
EXAMPLE
2:
Assume that a married
couple with a net worth of $7,000,000 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,
$3,500,000, 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 $1,500,000. 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.
This website is organized and written by the Law Office of Stephen C.
Gruber, 5050 El Camino Real, Suite 111, Los Altos, California 94022.