THE NEW ESTATE TAX LAW
In late December of 2010, Congress enacted a new tax law, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "TRA"). The TRA makes important changes in the estate and gift tax laws which will only apply to the years 2011 and 2012.
$5 MILLION PER PERSON CAN BE PASSED FREE OF
ESTATE TAX FOR THE YEARS 2011 AND 2012
Under the law in effect prior to enactment of the TRA, the size of the estate which could be passed free of federal estate tax increased over the years. In 1995 the amount passing free of estate tax was only $600,000, and the top estate tax rate was 55%. For taxpayers who passed away in 2005 to 2008, $2 million could be passed free of estate tax, and in 2009, $3.5 million could be passed free of estate tax. No estate tax was imposed upon taxpayers in 2010.
TRA drastically changed the impact of estate and gift tax on U.S. taxpayers. In 2011 and 2012, each taxpayer can pass $5 million free of gift tax during life or free of estate tax at death. If a taxpayer makes a taxable gift during those years, the maximum gift tax rate is 35%. Each taxpayer can also transfer $5 million to grandchildren free of generation skipping tax. If a married couple has an estate plan with an A-B Trust, in 2011 and 2012, that couple can pass a total of $10 million free of estate tax. It is important to note, however, that the TRA sunsets in 2012. Beginning in 2013, unless Congress enacts another new estate tax law, the estate tax exemption amount will go back to $1 million and the estate tax rate will climb to 55%.
As a result of these changes to the federal estate and gift tax rules, the majority of Americans dying in 2011 and 2012 will not be subject to the federal estate tax. Nevertheless, the benefits of creating a comprehensive and thoughtful estate plan will continue to be just as important and beneficial to individuals and families. In California, it is still important to have assets titled in a revocable "living" trust to avoid the time and expense of probate.
At Robinson, Lyon & Fulton, a typical estate planning package includes: a revocable living trust, a pour-over will, powers of attorney for health care and financial affairs. It may be advisable to review your existing estate planning documents in light of the new changes to the federal estate and gift tax laws.
For further information about the new federal estate and gift tax laws, or to review and update your existing estate plan, please contact us for an appointment.
DO MARRIED COUPLES NEED AN "A-B TRUST" NOW THAT $5 MILLION IS EXEMPT FROM ESTATE TAX?
For many years, the A-B Trust has been a basic strategy commonly included in a married couple's estate plan to minimize estate taxes. This strategy was necessary when only $600,000, or amounts somewhat larger than this, could be passed free of estate tax. Many "living trusts" prepared by our firm and other firms for married couples in the last twenty years have this "A-B" feature. The feature is not a part of a trust for a single person.
As a result of the new estate tax legislation, many of our clients have asked whether the A-B Trust is necessary. In addition, we see many widows and widowers who do not understand that their trust is required to split into two separate trusts at the death of the first spouse. They are distressed to learn that, under the terms of their living trust, a modest estate, which may include only the residence and some investments and which does not exceed $1 million in value, must be divided between two trusts, and each trust thereafter must file its own income tax return.
Due to the downturn in the economy, which has decreased the value of real estate and financial assets, and the increase in the amount that can pass free of estate taxes, the A-B Trust may no longer be necessary in estates valued under $1 million. In this article, we will explain how the A-B Trust works, set forth the advantages and disadvantages of this trust structure, and describe other alternatives available if an A-B Trust is no longer suitable for your estate.
At the death of the first spouse, the trust property is divided into two separate trusts, the "A Trust," also known as the "Survivor's Trust," and the "B Trust," also known as the "Bypass Trust," the "Exemption Trust" or the "Credit Shelter Trust." The decedent's share of the trust assets, or the amount that passes free of estate tax, whichever is less, is required to be transferred into the "B Trust" at the first death. Depending upon the terms of the "B Trust," the surviving spouse is usually the trustee of the "B Trust" and may distribute the assets to himself or herself for health, support, and maintenance. The assets funding the "B Trust" are no longer included in the surviving spouse's estate. This effectively doubles the amount that can pass to the couple's heirs free of estate tax. The "A Trust," the Survivor's Trust, holds the surviving spouse's property and is subject to total control by the survivor. At the surviving spouse's death, the "B Trust" assets will pass to the couple's heirs free of estate taxes. The "A Trust" assets will be subject to estate taxes if the surviving spouse's assets are greater than the estate tax exemption amount in the year of the survivor's death.
ADVANTAGES OF THE A-B TRUST
- Protection from estate tax
- Married couples can double the amount they can pass to their heirs free of estate tax.
- Asset protection
- The "B Trust" is irrevocable and its assets cannot be easily attached by the surviving spouse's creditors.
- It is possible to fund the "B Trust" years after death
- A disclaimer trust, an alternative discussed below, must be funded within nine months of the death of the first spouse.
- Surviving spouse cannot amend the "B Trust" – an advantage and a disadvantage.
- In "blended families," the surviving spouse cannot amend the "B Trust" to favor his or her own children and disinherit step-children or otherwise change the deceased spouse's distribution. In addition, the surviving spouse cannot amend the "B Trust" to give everything to a new spouse.
DISADVANTAGES OF THE A-B TRUST
- Mandatory funding even if estate is small
- Even if the estate is under $1 million, it must be divided into an "A Trust" and a "B Trust" after the death of the first spouse.
- Income tax return may have to be filed annually for the "B Trust"
- The survivor will also have to file his or her own income tax return.
- Surviving spouse cannot amend the "B Trust"
- Some couples want to give the surviving spouse the power to amend the trust if circumstances change after the death of the first spouse. In the event that beneficiaries are having creditor problems or substance abuse problems or simply would not be able to manage their inheritances wisely, it can be very useful for the surviving spouse to have the ability to amend the trust.
ALTERNATIVES TO THE A-B TRUST
If both spouses are still living, they can amend their trust to delete the "B Trust." The following are alternatives.
SURVIVOR'S TRUST ONLY If a married couple's estate is valued at $1 million or less, under current law, they probably do not need an A-B Trust to avoid estate taxes unless they think that their assets will increase in value over $1 million during their lifetimes. After the first death, all assets can be held in the survivor's trust if both spouses feel comfortable that the survivor's ability to amend that trust would not be used to defeat the couple's mutual estate plan.
DISCLAIMER TRUST The disclaimer trust is an alternative to the A-B Trust. Unlike a typical A-B Trust, the disclaimer trust does not require the trust assets be split between two trusts at the death of the first spouse. A disclaimer trust gives the surviving spouse the option to "disclaim" some or all of the deceased spouse's assets into a disclaimer trust if it appears to be necessary to minimize estate taxes. However, a disclaimer trust must be funded by the surviving spouse within 9 months of the first spouse's death. In addition, the surviving spouse must not use the assets to be disclaimed before the disclaimer is made. If a couple has an estate plan that includes a disclaimer trust, it is essential that the surviving spouse consult an attorney immediately after the death of the first spouse to determine whether the disclaimer trust should be funded.
PORTABILITY OF EXEMPTION BETWEEN SPOUSES The TRA, the new tax law, also created a new concept, commonly referred to as "portability." Prior to enactment of the TRA, the unused portion of an individual's estate tax exemption was not transferable to his or her surviving spouse. Use of an A-B Trust or disclaimer trust was the only way to use this exemption. Portability now allows a surviving spouse to take advantage of the unused portion of the estate tax exemption of his or her deceased spouse, thereby providing the surviving spouse with a larger exemption amount on his or her death. However, portability is only guaranteed for 2011 and 2012, and portability is only available if a federal estate tax return is timely filed after the first death and portability is elected on that return. At this point in time, it is not possible to rely on portability to minimize estate taxes in the larger estate.
To discuss the best option for your estate plan, please contact our offices.
