October 6, 2015
For many years estate planners worried foremost about avoiding the federal estate tax because it could take a bite out of the estate of as much as 55%. In order to combat this result a reasonably common solution for married couples was to establish a system in which the first spouse to die would create either through the will and/or a living trust a provision wherein the first assets would go to the “family” trust equal to the then non-taxable amount equivalent to the maximum credit available to that size of estate. The rest of the estate would then go to the spouse or a trust for the spouse. For convenience, the spousal trust, if any, was often referred to as the “A” trust and the family trust was referred to as the “B” trust. The amount passing to the spouse, either directly or to a spousal trust, was automatically and entirely free from any estate tax of the decedent. This pattern meant substantial estate tax savings for most estates but particularly for those of modest size, at least for the estate of the first to die. The estate of the surviving spouse would then be subjected to the possibility of the high 55% rate.
However, in 2010 Congress substantially revised the estate tax, starting in 2011 with an estate tax credit equal to a $5 million non-taxable estate, indexed to increase over the years in accord with the inflation rate (the 2015 credit equivalent number is $5.43 million), and a provision for the surviving spouse to carry over whatever portion of the credit that was not used on the return of the first spouse. This certainly appears to be a very significant savings for the taxpayers. Many states have non-taxable numbers which are less than the federal credit, which means the planning can be complicated.
In fact, the major thrust in estate planning now is to focus on saving and protecting the estate assets as much as possible from exposure to the high income tax rates (up to 42%). However, what about the estate of those spouses whose plans still were structured with the “A” or “B” trust scenario?
For a couple with assets of $10 million and up, the change in law would have minimal effect on the allocation of the estate between the spouse/spousal trust and the family trust. The results for the more modest estate, say $6 million, following the instruction to establish the family trust at the maximum estate tax credit amount, the executor would be required to place $5 million in the family trust leaving only $1 million for the spouse/spousal trust. Needless to say, the results for an even more modest estate of $4 million would move the entire $4 million to the family trust and leave nothing for the spousal trust.
Is this the result that a normal couple had planned? Probably not, but if the documents contain the usual “A” and “B” provision, there is little room for the executor to reinterpret. Of course, normally under these provisions the spouse can receive the income of the family trust and under certain restrictions might receive some of the principal. This alternative may require professional evaluation and become expensive.
There are new provisions that have been developed to achieve a more equal split and take advantage of the much higher estate tax credit, but to benefit from these new provisions the documents that were executed twenty and thirty years ago must be revised to be certain that the desires of the tax payers will be completely and satisfactorily achieved. Everyone who has not reviewed their estate documents recently should do so and consult with their advisors.
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