Trusts, which can range from simple to extremely complex, are a standard tool in the anti-estate- tax arsenal.
There is just one firm rule: If the trust benefits a spouse, “you must cause the trust to be included in the second spouse’s estate, for estate- tax purposes,” says Samuel Donaldson, a professor of law at Georgia State University. “There may be a lot of gain inside the trust. Because it’s subject to estate tax, it gets the step-up in basis. If it’s not included in the second spouse’s estate, the assets would have the same basis as at the first spouse’s death.”
Trust options include, but are certainly not limited to:
- Credit shelter trust: If, between the first spouse’s death and the second, the estate is likely to grow beyond what the portability will shelter, Donaldson suggests that members of a couple leave everything outright to the surviving spouse, but put a provision in the will saying that disclaimed assets must pass into a credit shelter trust. “Which to choose depends on the assets, the expected appreciation between the two deaths, the consumption habits of the surviving spouse, and the estate-tax exemption in place at the second spouse’s death,” Donaldson says.
- Clayton QTIP trust: Clients who want to leave assets in trust for the surviving spouse (and potentially other beneficiaries) should use a Clayton QTIP trust, Donaldson suggests. “It’s just like an ordinary QTIP, but to the extent that you do not make a QTIP election on the assets sitting inside the trust, the unelected assets pour over automatically into a credit shelter trust,” he says.
- Spousal limited access trust: This irrevocable trust lets clients use their gifting exemption while still retaining access to the gifted assets. Spouses each create an irrevocable trust and contribute assets up to their exemptions. Each spouse is the beneficiary of the other spouse’s SLAT; spouses can also name additional beneficiaries. No estate taxes are due on the trust assets at the death of either spouse. “You can withdraw assets on a limited basis, and you have control over how assets are invested. The spouse can access the trust if they are otherwise out of money — it’s the spare gas tank. If the spouse doesn’t need it, the beneficiaries get it,” says Charles Bennett Sachs, principal at Private Wealth Counsel in Miami.
- Irrevocable life insurance trust: Inside or outside a trust, life insurance can help beneficiaries pay estate taxes. When the death benefit is paid to a trust instead of an estate or individual, it stays outside the estate’s taxable value. Transfer an existing policy to a trust at least three years before the donor dies, however, or the IRS will consider the death benefit part of the taxable estate.
- Charitable remainder trusts: “Assets can pay to a client for life, to children for life, and to grandchildren for a period of time, and then go to charity,” Munro says.
- Irrevocable trusts: These can serve as vehicles for transferring a business to the next generation. Bruce Brinkman, a planner at Allen, Gibbs & Houlik in Wichita, Kan., cites as an example some clients whose estate is worth close to $30 million and who have a $6 million estate-tax liability. They want to move a company they own out of their estate now, before it appreciates further. To minimize estate tax, Brinkman recommends that they gift about half the company to an irrevocable trust, with the three adult children as beneficiaries. Appreciation and distributions will happen outside the estate and will not be subject to income tax — and the trust can use the distributions to buy the other half of the company over 10 to 15 years.
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