James H. Beauchamp

TAX SHELTERED TRUSTS

Tax sheltered trusts are revocable trusts, with added provisions. The purpose of these added provisions is to help heirs (other than husbands and wives) shelter the estate from some federal estate taxes. In 2011 and 2012, most people won’t be affected by federal estate taxes, because their taxable estates will be less than $5,000,000, should they die in those years. However, the tax laws change from year to year, and as things now stand, if a person dies in 2013 (or any year after), and the person owns taxable assets over $1,000,000, the person’s estate will be required to file a federal estate tax return, and if the taxable estate is over $1,000,000, the tax rates on that sized estate begin at 41%, and top out at 55% (the tax rates are graduated, based on the size of the taxable estate; the rates are given at another location on this website). This article discusses future events, i.e., deaths occurring in the year 2013 and thereafter. Suppose you die in 2013 and have an estate of $1,000,000. You get a tax break, because the Internal Revenue Code grants a credit to estates, which is the equivalent of $1,000,000 in assets, and this will reduce the overall estate taxes somewhat (the actual credit is $345,800).

So what do tax sheltered trusts (TSTs) do? If properly implemented, TSTs double the amount of tax credit, if you are married. Let’s muddle through the mechanics of how this works.

Determine Net Worth First. The starting point begins with an assessment of your actual net worth. This assessment will also give you a fair indication of how much of your estate is potentially taxable. Once you know the size of your estate and the potential estate tax, you can take specific steps to eliminate tax in some cases, minimize it in others, and insure that there's money on hand to pay what's due.

The Gross Taxable Estate. For valuation purposes, your gross taxable estate includes every type of property you own "to the extent of your interest in it." For citizens and legal residents, this includes all property, wherever it's located. Also included is property that you may have disposed of legally, but have continued to control during your lifetime. And your gross taxable estate may include transfers of property with a retained life estate, transfers that take effect at death, transfers that are conditional on survivorship, and transfers made three years before death. Once you know whether your estate might be taxable, please take into account the “marital deduction” (next paragraph).

Marital Deduction. You can leave an unlimited amount of your estate to your spouse, free of federal estate tax. During your lifetime, you can make a gift to your spouse without any gift tax consequences. (There are restrictions on gifts to spouses who aren't US citizens, although careful planning can avoid many of these taxes.)

Death of First Spouse. Estate problems generally will not arise until your spouse dies. Then, unless you've planned ahead, anything you own over $1,000,000 (assuming you die in 2013) will be subject to progressively steep taxes.

With proper planning, you and your spouse can shelter as much as $2 million of property from federal estate taxes with a fairly simple device – a revocable living trust which has necessary language added to it. Using a revocable living trust with TST additions, you and your spouse can each pass along $1,000,000 free of federal estate taxes.

Here's an example of how to shelter your estate: First, divide your property equally between yourself and your spouse, with you and your spouse each owning $1,000,000 worth of property; you can accomplish such an allocation with a trust. If you can’t divide the estate equally because you own IRAs, then a bit more planning is required, but the same results can be achieved (see article on “Funding the B Trust”).

Use of Trust During Your Lifetimes. Because the trust instrument is revocable – that is, you can change it – you will not have to file any additional tax returns. As a matter of fact, you will be able to use your property much the same way you now use it. The primary difference in owning property in trust is this – title to the property will be in the name of a trustee (for example, you will be the trustee, and what you own will be in the name of Sam Jones, Trustee – assuming your name is Sam Jones). You will still be able to use the property, just as you now do.

When one of you dies, one part of the trust (valued up to $1,000,000) will pay the other spouse income for life. The trust can also allow the surviving spouse to use the assets, if necessary.

Meantime, the surviving spouse also has the unlimited use of the other $1,000,000 during his or her lifetime. On the death of the surviving spouse, the money in both trusts would go to your beneficiaries (your children, for example), without any federal estate taxes (assuming there are $2,000,000 of assets when the surviving spouse dies).

The same idea can be used for larger estates. For example, on a $3 million estate, if the money were simply left to your spouse, with no tax sheltering trust, and the surviving spouse then willed the estate to the children, the federal estate tax would be $1,290,800, and the credit would be $345,800. The net estate tax would be $945,000,

By using a tax sheltered trust arrangement, the tax would be $780,800, with an attendant credit of $345,800, or a tax of $235,000. Using a tax sheltered trust, the couple could save their estate $710,000 in federal estate taxes.

One other word of caution: this article does not take into account state estate taxes, which may increase the total estate taxes.

In summary, TSTs can lower estate taxes (even when someone dies in 2011 or 2012, and the gross estate is over $5,000,000). But language must be added to the trust to wind up with an estate tax benefit.

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