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Credit Shelter (A/B)Trust Legal Tax Angles: How to Save Taxes Without Going to Jail The phrase "credit shelter trust" trust (also known as an A/B trust) refers to a trust that is designed to make maximum use of the unified credit for estate taxes -- which is also known as the lifetime exemption. Each individual is allowed a once-in-a-lifetime exemption from estate and gift taxes. However, the exemption is computed as a credit against the estate and gift tax that is sufficient to offset the tax on an estate of a specified size. For 2004, that exempt amount is $1.5 million. For a married couple, there is an opportunity for combined exemption of $3 million. It's an "opportunity" because it requires some planning. For discussion purposes, let's assume that "John" and "Jane" have a little over $4 million worth of assets, but that $3 million belongs to John. John dies. The first $1.5 million of his estate is exempt from the estate tax, but he still has an estate of $1.500,000 -- which he leaves to Jane. In addition to the $1.5 million exemption for each person, the estate tax law allows for an unlimited exemption for assets left to a surviving spouse. Thus, there is no estate tax at the time of John's death because all of his property was left to his spouse. Then, a few years later, Jane dies. She still has the $1,000,000 that was in her own name and the $3,000,000 that was left to her by John. Assuming no change has been made to the estate tax exemption in the intervening years, Jane will also get an exemption of $1.5 million, but she will have a taxable estate of $1.5 million. The estate tax on that amount would be $448,000. Her children would get about $3,650,000. With a very small amount of advance planning and a modest expense for legal fees, the children could get the entire $4 million. How? By establishing a dual trust arrangement and by dividing the estate so that both John and Jane would have an estate of at least $1.5 million. The dual trusts don't need to become effective until one of them dies. Let's assume again that John dies first. But now, he has transferred $1 million of his $3.5 million of assets to Jane and his estate is $2.5 million. Jane now has a separate estate of $1.5 million. John leaves $1.5 million of his $2.5 million to a special trust in which the income will be paid to Jane for the rest of her life but the principal will be left to their children when Jane dies. Technically, this $1.5 million is left to the children and is offset by the $1.5 million exemption for John. However, the kids have to wait to get the money until after Jane has died. When she does die, her $1.5 million estate is also left to their children but is offset by the estate tax exemption. She also has $1 million of other assets that are subject to estate taxes -- but there is no estate tax on the $1.5 million left to the kids in the credit shelter trust. What if Jane dies first? It's the same as if John dies first, but in reverse. Jane now has an estate equal to the exemption amount and her estate is left in a trust that pays the income to John for the rest of his life and then pays the principal to the children after his death. A common objection to this arrangement (usually by the spouse with the most money) is that the current spouse might remarry after the first death. Translation: John might be worried that Jane will remarry after John dies and the money that John would gift to Jane would end up going to a second husband or to children other than John's children. When a surviving spouse remarries they often put their assets into joint ownership with their new spouse -- without considering that if they die before the second spouse, those assets will go to the second spouse and not to the children of the first marriage. The solution for this concern is to implement the two trusts now -- while both John and Jane are alive and healthy. The assets are placed in the respective trusts and are technically owned by the trusts. Until the parents die, they get the income from the trust. When either spouse dies, the surviving spouse still gets the income from the trust assets but the assets are held for eventual distribution to their children. A second spouse or future children could not be a beneficiary of those assets. Vern Jacobs Copyright, 2003 |
Books and Services by Vern Jacobs
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