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Credit Shelter
Trust
A Credit Shelter Trust is a receptacle for property that will
pass tax free to descendants or other beneficiaries because of the
federal estate tax exemption. The exemption currently is $2,000,000
per donor. As with any trust, the Credit Shelter Trust provides
flexibility in making distributions to beneficiaries, including the
ability to take into account special circumstances and needs of
beneficiaries arising subsequent to drafting or amending the trust.
It can optionally provide additional tax minimization and debtor
protection features for beneficiaries as with Spendthrift and
Special Needs Trusts and Generation Skipping Trusts.
The Credit Shelter Trust has advantages for married persons. It
allows the surviving spouse as primary beneficiary to benefit from
the trust without the property being included in her estate, and
hence taxed, at her death. For this reason it is sometimes referred
to as a Bypass Trust. Children or other descendants are usually
specified as remainder beneficiaries. The Credit Shelter Trust
concept applies as well to primary beneficiaries other than
surviving spouses. The credit shelter trust is also sometimes
referred to as the family trust.
The trust is funded during life or at death with property titled
in the decedent's name. It is normally funded up to the estate tax
exemption amount. Funding above this amount is sometimes done in
large estates to equalize spouses marginal estate tax rates, thereby
reducing combined tax exposure. If the trust is funded during the
donor's life it removes subsequent appreciation of the funds from
his estate (thereby reducing exposure to transfer taxation).The
trust can be structured so the donor pays the income taxes on trust
earnings - providing additional transfer tax relief.
To qualify for bypass treatment beneficiary interests in the
trust must be limited. Beneficiaries can have the income of the
trust, any additional amounts required for health, support,
education and maintenance, and a limited right to select remainder
beneficiaries. If more flexibility is needed an independent trustee
or a remainder-beneficiary cotrustee can be used to provide
additional amounts from the trust corpus.
If the primary beneficiary is unlikely to need benefits from the
trust it can be disclaimed if done in a timely manner thereby
allowing the property to pass directly to remainder beneficiaries.
This would avoid taxation in the estate of the primary beneficiary
of trust proceeds otherwise required to be distributed to the
primary beneficiary according to the terms of the trust.
Alternatively, an independent trustee can be used to provide
flexibility in allocating Bypass Trust benefits among beneficiaries.
Another option would be to leave the surviving spouse (or other
primary beneficiary) out of the Bypass Trust altogether. The
advantage is that it wouldn't depend on the beneficiary timely
executing a valid disclaimer.
At the other extreme is a situation where the primary
beneficiary's resources may be so limited that she is likely to need
all the Bypass Trust property during her life. In this case the Will
or Living Trust document can specify that the Bypass Trust is to be
funded (i.e., created) only in the event the primary beneficiary
disclaims an outright bequest. Thus, upon the death of the donor, if
the primary beneficiary found she needed all the bypass property
during her life she would simply accept the outright bequest.
Otherwise, she could disclaim and the Bypass Trust would be created
and funded - giving her protection in the future if her own
resources became depleted.
The Marital Deduction
Trust
The decedent spouse's estate over and above the amount that funds
the Bypass Trust can pass tax-free either outright or in trust to
the surviving spouse because of the unlimited marital deduction.
Marital deduction assets thereafter remaining in the surviving
spouse's estate at her death are subject to estate tax. The result
of using a Bypass Trust and the marital deduction is that all
federal estate taxes can be avoided in the estate of the first
spouse to die, and the property remaining in the Bypass Trust at the
surviving spouse's death escapes taxation in her estate.
When should the decedent spouse pass marital deduction property
to the surviving spouse in trust rather than outright? A trust can
provide the following: 1) more control over the ultimate disposition
of the property, 2) more flexibility in making beneficiary
distributions, 3) protection from trade and judgment creditors, and
4) multiple generation tax minimization.
To qualify for the marital deduction the trust must provide that
the surviving spouse is entitled to at least the income of the trust
for life. The trust can optionally provide the spouse with any
amounts over and above the income as desired. The two most common
types of marital deduction trusts are the Testamentary QTIP
(qualifying terminable interest property) Trust and the Life Estate
with Power of Appointment Trust.
When it is desirable to prevent a potential diversion of assets
from the decedent's family, such as may occur in the case of the
surviving spouse's remarriage or children from a previous marriage,
a QTIP Trust can be used. In addition to providing the surviving
spouse the income from the trust during her life the QTIP Trust can
optionally provide her with the greater of $5,000 or 5% of the
principal of the trust each year, any additional amounts required
for her health, education, maintenance and support, and the power to
specify remainder beneficiaries of the trust (except she cannot name
her estate or her creditors as beneficiaries).
The Power of Appointment Trust, on the other hand, gives the
surviving spouse more control over the trust property. This type of
marital deduction trust can allow her to specify the ultimate
beneficiaries and/or make discretionary distributions (to herself
and others) during her life. One advantage of this trust is it
allows the surviving spouse to make annual exclusion gifts to
children out of trust property to reduce her estate tax
exposure.
Using a QTIP Trust enables the executor to elect to qualify all
or a portion of the trust for the marital deduction. This may be
desirable, for example, when the surviving spouse's estate would
likely be taxed at a higher marginal estate tax rate if it included
the decedent spouse's entire estate over his tax free credit shelter
amount. Instead, the executor would elect to have part of the QTIP
Trust taxed in the decedent spouse's estate.
If it is desirable to remove marital trust income from exposure
to taxation in the surviving spouse's estate a disclaimer may be
utilized. If a trust naming the surviving spouse and children as
beneficiaries is to receive the disclaimed property there are limits
on the surviving spouse's ability to retain certain rights in the
trust.
Lifetime QTIP
Trust
For estate tax purposes it is desirable to title a married
couple's property in such a manner that if either one predeceases
the other the deceased spouse can utilized her estate tax exemption
and thereby pass that amount of their combined estate free of tax to
children. In order to do this the married couple must title property
in each person's name.
In some cases the breadwinner-spouse may be reluctant to transfer
property to his spouse outright for this purpose. This could be due
to a concern over a possible divorce or because of the other
spouse's financial history. (Generally, however, the divorce issue
would only arise where the property being transferred was not
already part of the marital estate, as in the case of inherited
property or property acquired prior to the marriage which is kept
separate from the marital estate.)
A Lifetime QTIP Trust can utilize the non-breadwinning spouse's
estate tax exemption without giving the spouse complete control over
the transferred property. As with a testamentary QTIP Trust the
spouse must at least receive the trust income.
Generation Skipping
Trust
Generation skipping transfer taxes apply to transfers which skip
a generation, as with transfers to grandchildren. They are in
addition to estate taxes. The first $2,000,000 transferred is exempt
from generation skipping taxes. Over that amount generation skipping
transfers are taxed at the maximum marginal estate tax rate
(currently 50%).
A Generation Skipping Trust is an irrevocable trust designed to
utilize this exemption in a manner which benefits multiple
generations. This is accomplished by limiting distributions from the
trust based on specified needs or purposes, such as to provide
healthcare, education, maintenance or support, or by having an
independent cotrustee serve with authority to make additional,
discretionary distributions. In Massachusetts, the must terminate
within 21 years after the death of the last beneficiary alive at the
time the trust commences.
If your children are likely to incur estate taxes at death, or
are unlikely to need benefits from your estate after your death, the
Generation Skipping Trust may be advisable to provide a foundation
for the needs of multiple-generation descendants such as for
healthcare, education or support. These trusts can permit the
trustee to make discretionary distributions to your immediate
children if needed.
Normally, annual exclusion gifts to grandchildren are not charged
against the $2,000,000 generation skip exemption. However, they will
be charged against the exemption if the gifts are made in trust
unless the trust is solely for the benefit of one grandchild (one
trust for each grandchild) and the assets of the trust are included
in the grandchild's estate at death. The sooner you transfer to
grandchildren the better since post transfer appreciation will not
be charged against the exemption if a timely election is made.
Crummey Power
Trust
A Crummey Power Trust is an irrevocable trust designed to qualify
contributions as nontaxable annual exclusion gifts while limiting
access by the beneficiaries to the trust property. This is done in
order to control the amount and timing of distributions to provide
for the beneficiaries well being over time. Qualifying annual
exclusion gifts to the trust are a multiple of the number of trust
beneficiaries, including in some cases contingent remainder
beneficiaries (i.e., a $24,000 transfer to a trust with two
beneficiaries qualifies as a $12,000 annual exclusion gift to each
beneficiary). The trustee should be someone other than the donor or
someone under his control.
In most circumstances, beneficiaries go along with the donor's
plan to have the funds stay in trust, but they must be notified of
the gifts and have the right to withdraw the contributions within a
limited time period (usually 30 days). After the withdrawal period
the terms of the trust determine when any distributions are made to
beneficiaries. The Crummey Power Trust can serve as an Irrevocable
Life Insurance Trust (see below).
2503(c) Minor's
Trust
Like the Crummey Power Trust this type of trust is irrevocable,
can serve as a receptacle for insurance on the life of the donor,
and can qualify for the annual gift tax exclusion (if the trust
provides that funds can be used for the minor's benefit if needed).
Unlike the Crummey Power Trust, however, the 2503(c) Trust can have
only one beneficiary and there is no need to notify the beneficiary
of contributions.
The assets in the trust must be distributed when the minor
reaches 21 unless it provides a limited withdrawal period (commonly
30 to 60 days) upon the minor's 21st birthday, after which amounts
not withdrawn can continue to be held in trust. Alternatively, the
trustee can purchase an annuity and give it outright to the minor at
the age of 21, thus effecting a desired payout over time.
The advantages of the 2503(c) Minor's Trust trust are twofold:
potentially lower income taxes on family assets and reduced exposure
of the donor to gift and estate taxes.
An alternative to the 2503(c) Trust is titling the gifts in the
name of an adult as custodian of the minor under the Uniform
Transfers to Minors Act or similar local law. Although this may be
simpler than the 2503(c) trust it is less flexible because it must
end, and the funds must be distributed to the minor, when the minor
reaches the age of majority. Furthermore, if the custodian is a
parent the proceeds would be included in the parent's estate at his
death because he could have used the funds to fulfill his own child
support obligation.
Irrevocable Life Insurance
Trust
An Irrevocable Life Insurance Trust is a trust that holds life
insurance with a death benefit payable on the death of a named
individual (usually the donor of the trust). This planning vehicle
combines the standard life insurance feature of no-tax on income and
appreciation with the benefit of no-estate-tax on payment of death
benefits. To achieve the latter feature the trust holding the life
insurance must be irrevocable, it cannot be under the control of the
donor, and the donor cannot have any incidents of ownership in the
policy within three years of his death.
The donor typically funds the premium payments paid by the trust
with annual exclusion gifts made to the trust. To satisfy the
present interest requirement of an annual exclusion gift the trust
must provide that beneficiaries have the right to withdraw gifts to
the trust for a specified period of time (usually 30 days). The
trust language provides that if the gift proceeds are not so
withdrawn the power to withdraw lapses. This present interest
feature is the basis of a Crummey Power Trust. After the power to
withdraw lapses the funds can be used by the trustee to pay
premiums.
Tax Favored Giving
Strategies
A donor can give up to $3,500,000 in 2009 (see federal estate tax
table) credit free of transfer taxes. It doesn't matter whether
the transfers are made during the donor's life or at his death. The
exemption is commonly referred to as the "unified credit", the
"applicable exclusion amount" or the "credit shelter amount".
An additional exemption is the annual gift tax exclusion. $13,000
($26,000 for married persons) can be given to each donee per year
without being charged against the donor's lifetime unified credit.
No reporting of such gifts is required. Unlimited transfer tax free
gifts may also be made in the form of direct payments to health care
providers and schools, the latter for tuition and fees.
If you are likely to incur estate taxes at death it may be
advisable to give away more than the annual gift tax exclusion
amount (thus using up part of your unified credit). This would
exclude subsequent appreciation of the gift property from your
estate.
Even if a donor uses up his unified credit during his life it may
be advantageous to continue gifting over and above the annual gift
tax exclusion amount. This is because payment of gift taxes earlier
than three years before the donor's death removes the amount of the
tax paid from his taxable estate.
Annual exclusion gifts can be made in trust to provide advantages
for beneficiaries. These may include protection from trade and
judgment creditors, transfer tax exposure reduction, avoidance of
waste, fund management, and funding for multiple generation special
needs and incentives.
William F.
Smith Attorney at Law West Boylston, MA
508-835-2100 Moultonboro NH 603-253-2906
wsmith@mass-elderlaw.com
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