Estate Planning in the Current Environment

By Stephen J. Dunn

When the Federal estate tax returns on January 1, 2011, it will do so with a unified credit of only $1,000,000, unless Congress acts to increase it.  Every individual can pass property of a value up to the up to the unified credit free of Federal estate tax.  A unified credit of only $1,000,000 makes it especially important to make full use of each individual’s unified credit.

A married couple with a well-planned estate can pass twice the unified credit amount  free of Federal estate tax, regardless of the order of their deaths.  They do this by each spouse having a revocable trust.  The trusts provisions mirror each other, and provide that upon the death of the settlor (the creator of the trust), if the settlor’s spouse survives, the trust breaks into a marital trust and a credit shelter trust. Trust property of a value up to the amount of the unified credit in effect at that time passes to the credit shelter trust; the balance of trust property passes to the martial trust.  The martial trust and the credit shelter trust are irrevocable.

All the income of the marital trust is payable to the surviving spouse (Spouse Two) for his or her life.  Upon Spouse Two’s death, the assets in the marital trust pass according to the terms of the trust document (either according to a power of appointment granted to Spouse Two or to specified remainder beneficiaries).

Spouse Two is given the right to withdraw from the credit shelter trust either amounts needed for his or her health, education, maintenance or support (a “HEMS” power), or annually an amount which does not exceed the greater of 5% of the value of the assets in the credit shelter trust or $5,000 (a “5 or 5” power), but not both.  Upon Spouse Two’s death, the assets in the credit shelter trust pass to remainder beneficiaries specified in the trust document.

If the settlor is the last to die of the spouses, then upon his or her death the assets in his or her trust pass as specified in his or her trust document.

If each spouse has a revocable trust as outlined above, and they make sure that each revocable trust is funded with property of a value at least equal to the unified credit in effect from time to time, then at the death of the first spouse to die (Spouse One) there will be no estate tax on the property in his or her revocable trust.  Upon the later death of Spouse Two, the property in Spouse One’s martial trust incurs Federal estate tax, and the property in Spouse One’s credit shelter trust passes free of Federal estate tax.  Also at the death of Spouse Two, the property in Spouse Two’s revocable trust of a value up to the amount of the unified credit at that time passes free of Federal estate tax, and the balance of property in Spouse Two’s revocable trust is subject to Federal estate tax.  If all works as planned, at the death of the survivor of them the couple passes property of a value at least equal to twice the unified credit to the next generation free of Federal estate tax.

But there can be problems.  For example, if Spouse Two’s power to make withdrawals from Spouse One’s credit shelter trust is broader than the broader of a HEMS power or a 5 or 5 power, then Spouse Two has a general power of appointment over Spouse One’s credit shelter trust, with the consequence that the property in Spouse One’s credit shelter trust at Spouse Two’s death is subject to Federal estate tax in Spouse Two’s gross estate.

Or one spouse’s revocable trust may not be funded.  Let’s say that Spouse Two is the wife, and that her revocable trust is not funded.  If she survives Spouse One, as planned, then each spouse’s unified credit will be used.  At Spouse One’ death, there is no Federal estate tax.  At Spouse Two’s death, the property in Spouse One’s credit shelter trust passes free of Federal estate tax.  The property in Spouse One’s marital trust is subject to Federal estate tax at Spouse Two’s death, but it qualifies for Spouse Two’s unified credit.

But if the order of deaths is reversed, then at Spouse Two’s death there is nothing in her revocable trust.  Her unified credit is lost.  At Spouse One’s later death, the property in his revocable trust is subject to Federal estate tax in his gross estate with deduction for only his unified credit.

In recent years Congress increased the unified credit with a view of subjecting fewer estates to the Federal estate tax.  When the Federal estate tax was last in effect, in 2009, the unified credit was $3,500,000.  A unified credit of only $1,000,000 will place a premium on judicious drafting and funding of each spouse’s revocable trust.

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