I have written this article for information purposes, and I hope you learn something from it. Though I would like to state it is current and up to date, in all candor, I can't. In most cases, the concepts are relatively accurate (except for obviously old and dated materials, primarily related to taxes). You should confer with your own lawyer about issues that affect you and your family.
TAX SHELTERED TRUSTS
Tax sheltered trusts are revocable trusts, with added provisions. The purpose of these added provisions is to help heirs (other than husbands and wives) shelter the estate from some federal estate taxes. Most people won’t be affected by federal estate taxes, because their taxable estates will be less than $5,000,000. This article discusses estates over $5,000,000. If an estate is over $5 MM, the estate is taxed at a flat rate of 40%.
So what do tax sheltered trusts (TSTs) do? If properly implemented, TSTs double the amount of tax credit, if you are married. There is a related concept, known as the Portability Rule; this rule permits a married couple to use $10,000,000 worth of credits ($5,000,000 each), without creating a credit sheltered trust. If the spouses own properties in their own names, but in disproportionate amounts (e.g., the H owns $6,000,000 and the W owns $4,000,000). Under the portability rules, the spouses can “pool” their resources so as to achieve the full benefit of $10,000,000 exemptions from federal estate taxes. The portability rules are somewhat independent of the credit shelter rules, but no penalties attach if a couple doesn’t have a credit sheltered trust (there is a requirement to file a federal estate tax return in a timely fashion, i.e., 9 months after date of death, when the first spouse dies, in order to use the portability rules).
Let’s muddle through the mechanics of how credit sheltered trusts (or tax sheltered trusts) work.
Determine Net Worth First. The starting point begins with an assessment of your actual net worth. This assessment will also give you a fair indication of how much of your estate is potentially taxable. Once you know the size of your estate and the potential estate tax, you can take specific steps to eliminate tax in some cases, minimize it in others, and insure that there's money on hand to pay what's due.
The Gross Taxable Estate. For valuation purposes, your gross taxable estate includes every type of property you own "to the extent of your interest in it." For citizens and legal residents, this includes all property, wherever it's located. Also included is property that you may have disposed of legally, but have continued to control during your lifetime. And your gross taxable estate may include transfers of property with a retained life estate, transfers that take effect at death, transfers that are conditional on survivorship, and transfers made three years before death. Once you know whether your estate might be taxable, please take into account the “marital deduction” (next paragraph).
Marital Deduction. You can leave an unlimited amount of your estate to your spouse, free of federal estate tax. During your lifetime, you can make a gift to your spouse without any gift tax consequences. (There are restrictions on gifts to spouses who aren't US citizens, although careful planning can avoid many of these taxes.)
Death of First Spouse. Estate problems generally will not arise until your spouse dies. Then, unless you've planned ahead, anything you own over $5,000,000 (assuming you die in 2013) will be subject to progressively steep taxes.
With proper planning, you and your spouse can shelter as much as $5 million of property from federal estate taxes with a fairly simple device – a revocable living trust which has necessary language added to it. Using a revocable living trust with TST additions, you and your spouse can each pass along $5,000,000 free of federal estate taxes.
Here's an example of how to shelter your estate: First, divide your property equally between yourself and your spouse, with you and your spouse each owning $5,000,000 worth of property; you can accomplish such an allocation with a trust. If you can’t divide the estate equally because you own IRAs, then a bit more planning is required, but the same results can be achieved (see article on “Funding the B Trust”).
Use of Trust During Your Lifetimes. Because the trust instrument is revocable – that is, you can change it – you will not have to file any additional tax returns. As a matter of fact, you will be able to use your property much the same way you now use it. The primary difference in owning property in trust is this – title to the property will be in the name of a trustee (for example, you will be the trustee, and what you own will be in the name of Sam Jones, Trustee – assuming your name is Sam Jones). You will still be able to use the property, just as you now do.
When one of you dies, one part of the trust (valued up to $5,000,000) will pay the other spouse income for life. The trust can also allow the surviving spouse to use the assets, if necessary.
Meantime, the surviving spouse also has the unlimited use of the other $5,000,000 during his or her lifetime. On the death of the surviving spouse, the money in both trusts would go to your beneficiaries (your children, for example), without any federal estate taxes (assuming there are $10,000,000 of assets when the surviving spouse dies).
One other word of caution: this article does not take into account state estate taxes, which may increase the total estate taxes.
FYI, the $5,000,000 in credits is indexed annually. For persons dying in 2013, the amount is $5,250,000.
In summary, TSTs can lower estate taxes. But language must be added to the trust to wind up with an estate tax benefit.
©2013 James H. Beauchamp