The Unified Credit Freeze, Not the Philly Freeze
This is the second post is a three-part series on estate planning for a married couple. The first post concerned ethical, legal issues in estate planning for a married couple. This post concerns potential estate tax saving from establishing a separate revocable trust for each spouse and dividing the marital estate between the two trusts. The third post will address issues in funding the spouses’ revocable trusts.
You heard of the Boogaloo?
You heard of the Boston Monkey?
You heard of the Philly Freeze?
What we got for ya is the Detroit Demolition here tonight.
Hard Drivin’ Man was part of the J. Geils Band’s Live Full Housealbum, recorded April 21-22, 1972 at Detroit’s Cinderella Ballroom. The Geils Band hailed from Worchester, Mass., but Detroit was their second home. They were immensely popular in Detroit, and remain so. More on that later.
The unified credit is an opportunity every individual has to pass property to the next generation free of estate tax. Currently the unified credit is $5.25 million. Thus, an unmarried individual dying in 2013 can leave up to $5.25 million worth of property to his descendants or to other beneficiaries few of estate tax. A married couple with a well-planned estate can pass more than twice the unified credit amount on to the next generation free of estate tax.
For example, assume that a married couple owns property valued at $10,000,000, which they hold in a revocable trust. The trust instrument provides if wife survives husband, then upon husband’s death, the trust breaks into a credit shelter trust and a marital trust. Property in the revocable trust of a value up to the unified credit in effect at husband’s death passes to the credit shelter trust. The balance of property in the revocable trust at husband’s death passes to the marital trust. There is no estate tax at husband’s death.
Both the credit shelter trust and the marital trust continue in existence for wife’s surviving lifetime. All of the income of the martial trust is paid to wife at least quarterly. Wife can access principal of the marital trust without restriction. Although the property in the marital trust at wife’s death is subject to federal estate tax in wife’s estate, her unified credit can be applied against it. The balance of property in the marital trust at wife’s death passes to the beneficiaries designated in the trust instrument—in most cases the couple’s children.
Care is taken not to give wife a general power of appointment over the credit shelter trust. She can access the credit shelter trust, but only as needed for her health, support, or maintenance. At wife’s death, the balance remaining in the credit shelter trust passes to the beneficiaries designated in the trust instrument—generally, the couple’s children.
So, each spouse’s unified credit has been used. But if we reverse the order of deaths, wife’s unified credit is lost. The revocable trust continues in existence until husband’s later death. At husband’s death, all of the property in the revocable trust in excess of the unified credit then in effect is subject to estate tax.
To guard against unexpected order of deaths, we establish a revocable trust for each spouse, and divide the couple’s marital property between the two revocable trusts. There are also ethical and legal reasons for doing this, as noted in the first post in this series.
Internal Revenue Code § 2010(c)(4), added by the 2010 Tax Reform Act, provides some relief against loss of a spouse’s unified credit. It says that the unified credit amount of a surviving spouse dying after 2010 is the sum of the unified credit in effect at the surviving spouse’s death and the unused unified credit of the last deceased spouse of that surviving spouse.
But IRC § 2010(c)(4) is not complete relief for the failure to make full use of the unified credit of the first spouse to die to freeze the value of property for estate tax purposes at the time of that spouse’s death. The reason is that the unified increases at only the rate of increase in the consumer price index (“CPI”), but the value of property needlessly remaining in the gross estate of the surviving spouse likely increases at a higher rate than that of the CPI.
For example, assume that Wife dies in 2013, when the marital estate is worth $12,000,000. Husband survives to 2021. He does not remarry. In the eight years Husband survives Wife, the estate increases by an average of 8 percent per year net of expenses and taxes, but the unified credit increases by only 3 percent annually. Federal estate tax rates remains constant at the current rates for all pertinent times.
Marital Estate Divided Between Separate Revocable Trusts
Assume further that Husband and Wife established mirror revocable trusts, and divided the marital estate between the two rusts. Each trust instrument provides that if the settlor’s (creator’s) spouse survives, then upon the settlor’s death the trust breaks into a credit shelter trust and a marital trust. The credit shelter trust receives property in the revocable trust up to the amount of the unified credit in effect at the settlor’s death; the marital trust receives the balance of property in the revocable trust. The surviving spouse receives all income of the marital trust. The property in the marital trust is subject to a general power of appointment exercisable by the surviving spouse at his or her death. The surviving spouse may make withdrawals from the credit shelter trust as needed for her health, support, or maintenance.
There is no estate tax at Wife’s death. There is $2,283,094 in federal estate tax at Husband’s death, as follows:
|Gross estate: ($12,000,000 – $5,250,000) x 1.08 at 8 years||
|Unified credit: $5,250,000 x 1.03 at 8 years||
|Tax: [($5,834,236 – $1,000,000) x 40%] + $345,800||
Separate Revocable Trust Not Established and Funded for Wife
But if the couple does not establish a revocable trusts for each spouse and divide their property between the revocable trusts, there still is no estate tax at Wife’s death. But at Husband’s death there is $3,509,831 in federal estate tax, as follows:
|Gross estate: $12,000,000 x 1.08 at 8 years||
|Unified credit: $10,500,000 x 1.03 at 8 years||
|Tax: [($5,834,236 – $1,000,000) x 40%] + $345,800||
Although Husband’s estate can make use of Wife’s unused unified credit, her unified credit grew by only 3 percent per year, whereas the $5,250,000 of property that remained in Husband’s gross estate grew by 8 percent per year. The failure to establish a revocable trust for each spouse and divide the marital estate between the two trusts ultimately costs $1,226,737 [$2,283,094 – $3,509,831) in additional federal estate tax.
In addition to the ethical, legal reasons for establishing separate revocable trusts for each spouse and dividing the marital estate between them, there is significant potential estate tax saving available from doing so.
The J. Geils Band is opening for Bon Jovi at Ford Field on July 18, 2013. We’re going! I saw the J. Geils Band in concert in March, 1975 at Grand Valley State University, Allendale, Michigan. It was an unbelievable concert.
Update: The concert was outstanding! The J. Geils Band has had many Top 40 hits, and they played them all. Bon Jovi was good, too.