You Still Need to Plan Your Estate

By Stephen J. Dunn

The just-enacted Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010 makes great strides against the Federal estate tax burden that otherwise would have taken hold January 1, 2011.   The “exemption equivalent,” the amount of property an individual can leave free of estate tax, increases to $5,000,000.  The top estate tax rate is capped at 35%.  And the Act includes an unexpected provision to help a married couple make full use of each spouse’s exemption equivalent.

When a spouse dies, the surviving spouse succeeds to sole ownership of the couple’s marital property.  By virtue of the marital deduction, there is no estate tax.  At the surviving spouse’s death, the property passes to the couple’s children.  But there is no marital deduction at the surviving spouse’s death, and the surviving spouse’s estate is fully subject to estate tax except for that spouse’s exemption equivalent, $5,000,000.  The exemption equivalent of the first spouse to die is wasted.

To be assured of making use of each spouse’s exemption equivalent, each spouse needed a revocable trust, funded with at least the exemption equivalent amount of property.    Each trust would provide that if the settlor (creator of the trust) leaves a surviving spouse, the trust breaks into a marital trust and a credit shelter trust.  The credit shelter trust receives the first amount of property in the settlor’s revocable trust at his of her death up to the exemption equivalent in effect at his or her death.  All of the income of the marital trust is distributed to the surviving spouse.  The surviving spouse may be given the right to withdraw principal from the marital trust.  At the surviving spouse’s death, the remaining property in the marital trust passes either (1) as appointed by the surviving spouse, if the marital trust is a “power of appointment” trust, or (2) to the persons designated in the settlor’s trust document, if the marital trust is a qualified terminable interest property  (“QTIP”) trust  and the settlor’s personal representative has filed a QTIP election for the marital trust with the IRS.

The settlor’s credit shelter trust provides that the surviving spouse is entitled to withdraw from the credit shelter trust either (1) amounts necessary for the surviving spouse’s health, education, maintenance, or welfare (this is called a “HEMS power”), or (2) the greater of 5% of the value of property in the credit shelter trust or $5,000 each calendar year (this is called a “5 or 5 power”), but not both. If the surviving spouse’s withdrawal power over the credit shelter trust is any broader, the surviving spouse has a general power of appointment over the credit shelter trust, with the consequence that the property in the credit shelter trust will be subject to Federal estate tax in the surviving spouse’s gross estate.

At the surviving spouse’s death, the property in the first deceasing spouse’s marital trust and credit shelter trust, as well as the property in the surviving spouse’s revocable trust, passes as specified in the couple’s trust documents, generally to their descendants.  In such an estate plan, there is no estate tax at the death of the first spouse to die.  At the surviving spouse’s death, there is no estate tax on the first deceasing spouse’s credit shelter trust, and the first deceasing spouse’s marital trust is fully subject to estate tax.  Also at the surviving spouse’s death, the property in the surviving spouse’s revocable trust is exempt from estate tax up to the exemption equivalent, and subject to estate tax in excess of the exemption equivalent.

Such an estate plan enables a couple to leave their property to the persons they want to leave it to; to minimize estate tax on succession to their property and defer it for as long as possible; to avoid probate on succession to their property; and to protect their property from prospective claims of creditors.

But there are many potential pitfalls to prevent such an estate plan from working.  The trust documents may not be properly drawn.  The trusts may be unfunded or under-funded.

The just-enacted tax act includes a provision to help save the exemption equivalent of the first spouse to die.  Under the provision, the exemption equivalent available to a decedent’s estate includes the decedent’s basic exemption equivalent of $5,000,000, as well the unused exemption equivalent of his or her last deceased spouse.   This is unexpected and welcome additional relief from estate tax.  But it does not eliminate the need to plan your estate, for many reasons.

The Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010 sunsets on December 31, 2012 unless extended.   Upon expiration of the Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010, the exemption equivalent will revert to $1,000,000 per individual, and the top Federal estate tax rate to 55%.

And you still need to plan your estate to accomplish the non-tax objectives of estate planning:  to make sure your property passes to the persons you it to go to; to avoid probate on succession to your property; and to protect your property from prospective claims of creditors.

Leave a Reply