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USING A LIVING TRUST TO REDUCE ESTATE TAXES
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A living trust completely avoids probate and all the costs that go along with it. It can also be used by married persons to reduce or eliminate estate taxes.
If the net value of your estate (the value of all of your assets minus your debts) is more than $2,000,000 when you die, then federal estate taxes (death taxes) must be paid from your estate before it is distributed to your beneficiaries. If your estate is too small to be affected by this, then you can just skip over this section. But before you do, think for a moment: if you own a home or other real estate, it could be worth a lot more than you think. Real estate can easily appreciate in value over the years and can continue to appreciate after you or your spouse die. You may have purchased additional life insurance or your investments may have appreciated substantially, increasing your estate. Because a tax-planning living trust can save your family thousands of dollars - in addition to the probate savings - you may want to continue reading.
PURPOSE OF TAX PLANNING LIVING TRUST
MARITAL DEDUCTION - UNCLE SAM'S PLAN
TAX PLANNING LIVING TRUSTS
THERE ARE THREE TYPES OF TAX PLANNING REVOCABLE LIVING TRUSTS
CATASTROPHIC ILLNESS AND MEDICAID “SPEND DOWN”
SETTLING A TAX PLANNING LIVING TRUST
BEYOND YOUR TAX PLANNING LIVING TRUST
PURPOSE OF TAX PLANNING LIVING TRUST
Revocable tax planning living trusts are used between married persons for the purpose of:
Ø Avoiding probate at death or incapacity.
Ø Providing for the surviving spouse.
Ø Reducing or eliminating federal estate taxes on estates larger than $2,000,000.
Ø Preventing a surviving spouse from completely changing or revoking the common trust plan following the death of his/her spouse.
Ø Giving each spouse control over one-half of the assets in estates larger than $4 million.
Ø Deferring estate taxes on estates larger than $4 million.
Ø Permitting a spouse who has a separate trust with assets in excess of $2,000,000 to provide for his/her surviving spouse and to defer estate taxes.
Why consider a tax planning living trust?
Reducing federal estate taxes and avoiding probate are the primary reasons for using a tax planning living trust. A will containing tax planning provisions can save estate taxes, but the expense and delay of probate is also involved. A tax planning living trust will save the same amount of taxes and avoid probate, doubling the benefit for your family. To avoid any confusion, we need to review the two kinds of taxes that must be paid when you die - income taxes and estate taxes.
Income taxes
Your estate must file a final federal income tax return just as you do each year, regardless of whether or not you have a living trust. Most states will also require a final state income tax return to be filed. All income received by you in the year you die must be reported and any taxes owed on that income must be paid. Your living trust has no effect on your income taxes.
Estate taxes
The other tax is the “federal estate tax,” also known as the “death tax.” If the net value of your estate (the fair market value of all your assets less your debts) exceeds $2,000,000 when you die, then your estate must pay federal estate taxes before any distribution is made to your beneficiaries. The federal estate tax on the first $2,000,000 is $780,800; however, everyone receives a tax credit of $780,800, which means the first $2,000,000 is exempt from estate taxes. We will refer to this amount as the “exemption.”
Federal Estate Tax*
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Estate Size |
Estate Tax |
% Of Estate Taken |
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$ 0 - 2,000,000 2,500,000 3,000,000 3,500,000
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$ 0 230,000 460,000 690,000
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0.00% 9.2 15.3 19.7
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*Currently you pay no federal estate taxes on the first $2,000,000 you own. Any amount over $2,000,000 is taxed at 46% |
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The federal estate tax rate on amounts over the exemption starts at 46%. This can be very expensive as you can see on the above chart. The estate tax is due within nine months of your death and must be paid in cash. This means that real estate, farms, family businesses, antiques, heirlooms, and other assets often have to be sold quickly at “fire sale” prices to pay estate taxes.
Some states also collect a state death tax (also called an “inheritance tax”). Your tax preparer can help you estimate your estate death tax liability.
The estate tax is actually a double tax. Through the years, you have already paid income taxes on the assets that comprise your estate. And your estate may have to pay taxes on these assets again unless you plan ahead. A properly planned living trust can reduce these estate taxes.
The Economic Growth and Tax Relief Reconciliation Act of 2001 established periodic increases to the estate tax exemption. The following chart shows what the exemption will be for each year. This table expires during 2010. Then, for 2011 and beyond, the exemption returns to $1,000,000 per estate ($2,000,000 for couples using estate tax planning).
Estate Tax Exemption Amount
| 2002 | $1,000,000 |
| 2003 | $1,000,000 |
| 2004 | $1,500,000 |
| 2005 | $1,500,000 |
| 2006 | $2,000,000 |
| 2007 | $2,000,000 |
| 2008 | $2,000,000 |
| 2009 | $3,500,000 |
Determining your net estate
You should determine your net estate before you decide whether or not you need a tax planning living trust.
Your net estate is determined by adding up the current market value of everything you own, minus any debts and charitable contributions. Your estate includes the death benefits from all life or term insurance policies on your life (or others) over which you have any “incidents of ownership,” as defined by the IRS. This includes policies for which you have the right to name and change the beneficiary, borrow against the policy, or assign it, regardless of who actually owns the policy and even if the death benefits are paid to someone other than your estate. Also included are policies for which your employer pays the premiums and you have the right to name and change the beneficiary.
For example, assume your net estate is $1,900,000. You also have a term insurance policy with a $300,000 death benefit payable to your son. Because you owned the policy when you died and since you had the right to change the beneficiary, the $300,000 death benefit is included in your estate despite the fact that the proceeds will be paid directly to your son. As a result, your taxable estate is calculated at $2,200,000 by the IRS, resulting in a $92,000 federal estate tax.
It is very important for you to understand that the full death benefit of anything you own or have the right to change the beneficiary of is included in your taxable estate. Many persons are much closer to $2,000,000 than they realize, especially after including insurance death proceeds.
MARITAL DEDUCTION - UNCLE SAM'S PLAN
Uncle Sam created the “marital deduction” plan exclusively for married persons. Here is how it works: You, as a married person, can leave an unlimited amount of property to your spouse (provided he or she is a U.S. citizen) at your death without having to pay any federal estate tax. Under Uncle's marital deduction plan, no federal estate taxes are due when the first spouse dies.
So far this sounds great. But when the surviving spouse dies, the full value of the estate (including what you left your spouse and your spouse's own property) will be taxed before it can be distributed to the beneficiaries. The surviving spouse's estate is entitled to an estate tax credit equal to a $2,000,000 net estate, so the first $2,000,000 of the estate can go to the heirs tax-free, but any excess is taxed. The following example may help you to better understand how the marital deduction works.
Assume Husband and Wife have a $3 million estate. The husband dies leaving all of his property to his wife. Under the marital deduction plan, no estate tax is due. Then the wife dies. Her estate is valued at $3 million (her original share plus what her husband transferred to her by the marital deduction). Now look what happens!
Surviving Spouse |
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$ 1,500,000 Wife’s original share +1,500,000 Deceased husband’s share transferred to wife by marital deduction (no estate taxes) 3,000,000 Estate value at wife’s death -2,000,000 Wife’s federal estate tax exemption 1,000,000 Wife’s taxable estate
$ 460,000 Federal estate tax owed
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The marital deduction plan works fine when the first spouse dies because there is no estate tax liability for property transfers between spouses at death. The problem arises when the surviving spouse dies. In this case, a $460,000 estate tax is owed at the death of the surviving spouse because her estate value exceeded her estate tax exemption by $1,000,000.
But guess what? Each spouse is entitled to a $2,000,000 net estate exempt from tax, if they plan ahead. The husband didn't use his exemption. They could have passed up to $4 million to their heirs tax-free, but now the estate is only entitled to one exemption (the surviving spouse's exemption). Uncle Sam is very patient (and smart) - he'll wait until the surviving spouse dies and collect more taxes on a much larger estate.
Once again, you have a choice. You can do nothing and use Uncle Sam's plan. Or you can use your living trust to reduce or eliminate taxes and avoid probate.
Remember too, that people today are living longer (women often outlive their husbands by many years), and even a modest estate can appreciate greatly over time, especially if you own real estate or investments, or if you have large amounts of life insurance.
TAX PLANNING LIVING TRUSTS
Before we go any further, we should explain that a tax planning trust is a revocable living trust, with additional special provisions required by the IRS so that each spouse's $2,000,000 estate tax exemption is preserved.
Tax planning living trusts are based on the fact that each spouse is entitled to a $2,000,000 exemption. A husband and wife can pass up to $4 million to their heirs tax-free, provided they plan ahead with their living trust while they are both still alive and competent.
Common trusts vs. separate trusts
Spouses wanting to reduce or eliminate federal estate taxes have the option of creating a separate trust for each spouse and having separate estates while they are both still alive or they can use a “common” trust.
Most married couples own their property together and usually prefer having one "common" tax planning trust. This option is much simpler and more practical than establishing separate trusts and dividing all of the marital property into "his" and "hers" while both spouses are alive. All of the marital property is held inside of one common tax planning trust. It is not divided until one spouse dies.
If you want to pursue the common trust approach, don't get confused or sidetracked by using the wrong name. Even though they may look the same, a common tax trust is very different from a “joint” living trust. With a common living trust each spouse owns a one-half undivided share of each trust asset. This happens automatically as property is put into the trust. When the first spouse dies, each trust asset is "split right down the middle" giving each spouse one-half of the estate. By comparison, all of the property in a joint living trust is owned by the surviving spouse when the first spouse dies. Make certain you explain to your attorney that you want a common tax planning trust.
You and your spouse also have the option of using separate trusts. Most attorneys will recommend this because they aren't familiar with the common tax trust. The estate tax savings will be the same, but all of your marital property will have to be divided and put into each separate trust while both spouses are alive. This can be very complicated and not at all how most married people like to handle their business. For example, in whose trust do you put your home, stocks, bank accounts, cars, etc.? Separate tax trusts are most often found in remarriage situations, where the spouses have always held their assets separately, or where one spouse has separate property he or she wants to keep out of the marriage.
THERE ARE THREE TYPES OF TAX PLANNING REVOCABLE LIVING TRUSTS
AB common trust: Recommended for estates between $2,000,000 and $4 million or for larger estates where the couple wishes to maximize the amount of control given to the surviving spouse. The AB trust is sometimes referred to as the "By-pass trust" or the "Credit Shelter trust." It is the most popular tax planning trust.
QTIP common trust: Recommended for estates exceeding $4 million. It is also called the "ABC" trust.
QTIP separate trust: Recommended for married persons with a separate estate in excess of $2,000,000. It is a separate trust. This trust is also known as the "BC" trust.
AB Common Tax Trust
A common AB trust gives each spouse a one-half undivided interest in the trust property. All of the property is titled in the name of the common trust, which usually names both spouses as co-trustees. Upon the death of the first spouse, the surviving spouse divides all of the trust property into two shares. This does not require writing two new trusts, but only requires keeping two separate ledgers to account for the property that has been re-titled into each share.
One share - known as the "A" or "marital trust" - belongs to the surviving spouse as his or her property. This share remains revocable, meaning the surviving spouse has control of the marital trust property. The marital trust is not taxed until the surviving spouse dies.
The other share - known as the "B" or "family trust" - is made up of the deceased spouse's one-half share, up to $2,000,000. Any excess amount is placed into the marital trust by use of the marital deduction between spouses. Unlike the marital trust, the family trust is "irrevocable," meaning its provisions and beneficiaries cannot be changed by the surviving spouse. This protects the family trust assets if the surviving spouse remarries or changes the provisions of the marital trust. Since the family trust does not exceed $2,000,000, the amount of the federal estate tax exemption, no federal estate tax is due at the death of the first spouse. No estate taxes will be assessed against the family trust even if it increases in value during the lifetime of the surviving spouse. Its assets will ultimately pass to the beneficiaries free of estate taxes.
The surviving spouse can be the trustee of the marital trust and of the family trust, insuring total management and investment control for the survivor. A family member or a corporate trustee can also be named as trustee (or co-trustee) of the family trust. Typically, all of the family trust income is given to the surviving spouse during his or her lifetime, but the trust can be written so the surviving spouse receives no family trust income or a restricted income.
The surviving spouse can also be given the right to "invade" the family trust principal for his or her support, medical care and education if he or she runs short of funds in the marital trust and needs money for normal living expenses. There are some restrictions on how this is done, but they generally allow anything the survivor would need. The surviving spouse cannot have 100% control over the assets in the family trust, because that would legally give him or her ownership of them causing them to be taxed when the survivor dies.
So, for the rest of the surviving spouse’s life, he or she has complete control over his or her own trust, plus he or she gets all the income from the family trust and can withdraw principal from it if needed. And when the surviving spouse dies, the assets in both trusts (up to $2,000,000 each, a total of $4 million) will pass to the beneficiaries tax-free and without probate. What could be better than that?
The right to invade can be restricted or even eliminated. A properly planned AB trust will not allow the surviving spouse, as trustee of the family trust, to make a discretionary payment of income or principal to himself or herself. Instead, the trust should require that the decision be made by the other co-trustee. If there is no co-trustee, then the trust should require that the decision be made by the next successor trustee, who becomes a permanent co-trustee to act with the surviving spouse.
At the death of the surviving spouse, the property in the family trust must be distributed to the deceased spouse’s beneficiaries. The marital trust property is distributed to the surviving spouse’s beneficiaries who may be the same as for the family trust, or different if the surviving spouse made any changes to the marital trust.
An AB trust allows a husband and wife to pass $4 million to their heirs without any federal estate taxes - $2,000,000 at the death of the first spouse (even though the surviving spouse may have an interest in this share) and $2,000,000 at the death of the surviving spouse. The following chart shows how an AB trust works on an estate of $4 million.
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Result: No Probate. Beneficiaries receive $4 million and avoid all federal estate tax.
Advantages: Besides avoiding probate, providing for the surviving spouse and allowing married persons to pass $4 million to their heirs without any federal estate tax, an AB trust offers the benefit of equal control for each spouse. One-half of the common estate is placed into the deceased spouse's family trust, which is irrevocable and cannot be changed by the surviving spouse. This allows the first spouse to die to maintain control over one-half of the common assets.
The AB trust gives each spouse equal control even if the common estate is less than $2,000,000. For example, using the AB trust for a $800,000 estate would leave $400,000 in the family trust and $400,000 in the marital trust at the death of the first spouse, who keeps control of one-half of the estate. Interestingly, the AB trust is increasingly used by married persons without any federal estate tax liability for the express purpose of giving each spouse equal control of the estate.
If the estate is larger than $4 million, the AB trust will allow the survivor control of more than one-half of the estate. This may be acceptable if the spouses want the survivor to control as much of the property as possible, but if the spouses want to maintain equal control beyond $4 million, then they will need to use the QTIP tax planning trust discussed below.
QTIP Common Tax Trust
The QTIP common tax trust, also known as the ABC tax planning trust, is used for estates larger than $4 million. A QTIP trust does not save federal estate taxes beyond the $4 million permitted to a husband and wife. It lets each spouse control one-half of the portion of the estate that exceeds $4 million, and it defers federal estate taxes.
In the AB trust, once the estate exceeds $4 million, the surviving spouse will receive and then control more assets than the deceased spouse. For example, a $4.6 million estate using an AB trust will be divided at the death of the first spouse by placing $2,000,000 into the family trust and $2.6 million into the marital trust. Since the marital trust is still revocable, the surviving spouse controls more than one-half of the estate.
Congress created the QTIP trust to solve the problem of disproportionate control between spouses. QTIP means "qualified terminable interest property." This sounds very complicated, but it really isn't. This is how the QTIP trust works with a $4.6 million estate.
At the death of the first spouse, the estate is split in half so $2,300,000 goes into the marital trust owned by the surviving spouse. The remaining one-half, or $2,300,000 belonging to the deceased spouse, is then divided into two shares. The first share is placed into the family trust and will not exceed $2,000,000, because this is the amount of the federal estate tax exemption. The excess, or $300,000, is placed into a third trust called the "C" or "QTIP" trust. The following chart will help you understand how a QTIP trust works with a $4.6 million estate.
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Result: No Probate. Beneficiaries receive $4 million free of federal estate tax. Estate taxes on $600,000 (excess over $4 million) are deferred until death of surviving spouse. Since the family trust does not exceed $2,000,000, the amount of the federal estate tax exemption, no tax is due at the death of the first spouse. Estate taxes on the QTIP trust share are deferred until the surviving spouse dies. The marital and QTIP trust shares are included in the surviving spouse's estate. In our example, the taxable estate at the death of the surviving spouse is $2.6 million, made up of $2,300,000 in the marital trust and $300,000 in the QTIP trust share. After the surviving spouse's $2,000,000 exemption is applied, federal estate taxes of $276,000 are owed on the $600,000 excess. This amount is paid based on the amount of tax generated by each trust share ($138,000 by the marital share and $138,000 by the QTIP share), unless the trust specifies a different formula for allocating the estate tax liability between the two trust shares.
The surviving spouse has complete control over the marital trust. Under IRS regulations all of the income from the QTIP trust must be paid to the surviving spouse. The survivor can also be paid the income from the family trust and be given the right to invade the principal of both the QTIP and the family trust shares for his/her support, medical care and education. A QTIP tax planning trust, like the AB trust, may also be written so the family trust income and the right to invade the principal of the QTIP trust share or the family trust share is restricted or prohibited.
Advantages: Besides avoiding probate, providing for the surviving spouse and allowing married persons to pass $4 million estate tax free to their beneficiaries, a QTIP trust offers these benefits:
Equal control for first to die: One-half of the common estate is placed into the deceased spouse's family and QTIP trust shares. These trusts are irrevocable, and cannot be changed by the surviving spouse, so the first spouse to die retains equal control.
Defer estate taxes: The QTIP trust share is not taxed until the surviving spouse dies. The estate is kept intact so a greater amount is available to produce income and principal, if needed, for the surviving spouse during his or her lifetime.
QTIP Separate Tax Trust
This trust, also known as the "BC" or "BC-QTIP trust,” is for a married person having a separate estate in excess of $2,000,000. It is commonly used in a remarriage situation where one spouse has substantially more property than the other spouse or when the spouses want to use separate trusts.
The QTIP separate trust eliminates probate, allows control of separate assets after death, provides for a surviving spouse, and defers estate taxes until the death of the surviving spouse. The following chart will show how a BC-QTIP trust works with a married person who owns $2,300,000 of separate property.
When the trust owner dies, the BC trust is divided into two shares the "B" or family trust share and the "C" or QTIP trust share. The family trust is funded with assets equal in value to the federal estate tax exemption or $2,000,000; the excess or $300,000 is put into the QTIP trust share.
Surviving Spouse
Result: No Probate. Beneficiaries receive $2,300,000 free of federal estate tax. Estate taxes on $300,000 (excess over $2,000,000) are deferred until death of surviving spouse.
The family trust has no estate tax liability because its value is $2,000,000, the amount of the estate tax exemption. Estate taxes are deferred on the QTIP share until the surviving spouse dies.
The family trust and the QTIP trust share are irrevocable. All of the net income from the QTIP trust share must be paid to the surviving spouse for his or her lifetime. In addition, the trust may be set up to allow the surviving spouse to receive the net income from the family trust and principal from both the QTIP and the family trust shares for his or her support, medical care and education. When the surviving spouse dies, the property in both trust shares is distributed to the beneficiaries of the first spouse.
Your surviving spouse can be trustee of the family trust and the QTIP trust, but since this trust usually contains your separate property, you might not want your spouse to be the trustee of it - and would instead name a family member or a corporate trustee.
The QTIP separate trust offers another important benefit: it allows the deferred estate tax liability on the QTIP trust to be eliminated if the survivor has a small estate. Using our example, let's assume the surviving spouse has a $200,000 separate estate when he or she dies. The taxable estate is $500,000 - $200,000 in separate property plus the $300,000 in the deceased spouse's QTIP trust. Since the surviving spouse's exemption amount is $2,000,000, the $500,000 is free of estate tax. The first spouse's $2,000,000 exemption amount protects the family trust share. In effect, the $300,000 QTIP share “borrows” a portion of the unused surviving spouse’s $2,000,000 exemption. So the entire $2,500,000 estate is protected from the estate tax. This means that both spouses transfer a total of $2,500,000 million to their respective beneficiaries tax free.
Advantages: Like the AB trust and the ABC trust, a BC-QTIP trust avoids probate and can provide for the needs of the surviving spouse. It also offers the following benefits:
Complete control of separate assets: At the death of the spouse-owner, the family trust and the QTIP trust share become irrevocable. This means that the spouse-owner has complete control over his or her separate property after death.
Defer estate taxes: The QTIP trust share is not taxed until the surviving spouse dies, keeping the estate intact so more assets are available to produce income and principal, if needed, for the surviving spouse during his or her lifetime.
If Your Spouse Is Not A. U.S. Citizen
A non-citizen spouse is not entitled to the unlimited marital deduction. This means that without additional planning, the citizen spouse's estate will be taxed if it exceeds $2,000,000 before distribution to the non-citizen spouse. This problem can be solved by using a QTIP common or a BC-QTIP separate trust containing special provisions which allow the trust to qualify under IRS regulations as a "qualified domestic trust" also called a "QDOT." Also, effective July 14, 1988, a citizen spouse cannot transfer more than $100,000 per year to the non-citizen spouse (including consideration in the form of debt reduction), without incurring a tax liability. To avoid problems, consult with a professional specializing in this area before you transfer any property to your non-citizen spouse or set up a tax planning living trust.
What About Using A Will With Tax Planning Provisions?
You may have heard of estate tax planners who incorporate "tax planning trusts" into a will to reduce estate taxes in much the same way as a tax planning living trust. But watch out - a will must be probated before the trusts can go into effect - so you haven't avoided probate. By the time the trust goes into effect, a portion of your estate is lost to probate costs, not to mention all the other problems that accompany probate. With a tax-planning living trust you can reduce estate taxes without probate.
CATASTROPHIC ILLNESS AND MEDICAID “SPEND DOWN”
A tax planning living trust, like any revocable living trust, does not protect against Medicaid spend down requirements for catastrophic illness. Congress has increasingly restricted the use of trusts to avoid the Medicaid spend down rules. The assets in the trust belong to you and are subject to your debts and obligations, which include the medical needs of both you and your spouse. For more complete long-term care protection, you should consider long-term care insurance.
SETTLING A TAX PLANNING LIVING TRUST
Your trustee has a legal duty to follow detailed IRS procedures at the death of each spouse in order to take advantage of the estate tax savings. These requirements are in addition to the basic trust settlement procedures such as paying bills, distributing property, etc. For example, your trustee must correctly divide the trust property into the trust shares (marital trust, family trust, QTIP trust) required by the type of tax trust you used, apply for a new tax identification number for the family trust (and QTIP trust), and prepare and file the appropriate federal and state estate tax returns. The estate tax savings may be lost and substantial costs and penalties may result if the IRS procedures are not followed, so it is very important that your tax trust be settled correctly.
Your trustee has a legal responsibility to hire a competent professional (an experienced accountant, CPA, or tax attorney) if the trustee feels he or she lacks the experience to settle the trust. A properly prepared trust will authorize the trustee to hire outside professionals if the trustee thinks they are needed. Remember, your trustee can be held personally liable to the beneficiaries of your trust for lost tax savings, audit and legal fees, and penalties, if the settlement isn't done correctly.
Costs of settling a tax planning trust will vary depending on your situation, where you live and the professional used. We recommend that you budget approximately $3,000 - $5,000 at the death of each spouse. These estimates do not include appraisal costs or tax audit expenses. Tax planning trusts require additional paperwork and documentation in order to capture the federal estate tax savings produced by your trust. These costs (which are deductible expenses) are nominal compared to the potential estate tax savings. For example, under current law a properly prepared tax trust will generate a $920,000 savings on a $4,000,000 estate, so it pays to settle your trust correctly.
Settling a tax planning trust is primarily an accounting function, so we recommend using an accountant or CPA to settle your tax trust. (Just make sure he or she has experience in this area.) Many accountants and CPA's routinely handle all of the accounting and tax paperwork, then hire an attorney to review what they have done and write an opinion letter verifying that everything has been prepared according to the trust instructions and IRS regulations. We recommend that you contact a professional after you set up your tax planning trust to review your situation and give you a cost estimate for settling your tax trust. This can save your trustee time and money later.
No one can guarantee that your trust will not be audited. Obviously, thorough and accurate settlement documentation reduces the likelihood of an audit and improves the chances that your trust will be able to successfully pass an audit. Audits may result in additional fees. Your trust will be responsible for audit costs, including penalties and interest.
Listed below are some of the special procedures required by a tax planning living trust at the death of the first spouse. The same procedures are followed at the death of the second spouse, except for the division of property into the appropriate trust shares.
These requirements are not the result of choosing to do a tax planning living trust. As we earlier explained, estate tax planning can be done through a will or a living trust. In either case the IRS settlement procedures are the same. But by using the living trust, you have eliminated the cost and delay of probate in addition to reducing or eliminating your estate taxes.
Checklist For Settling A Tax Planning Living Trust
Ø Inventory all assets (including detailed listing of all safe deposit box contents) and determine all liabilities.
Ø Establish fair market value of all assets, including personal property. Secure independent appraisals, if necessary.
Ø Apply for federal tax identification number for the Family Trust (and the QTIP Trust, if applicable).
Ø Divide the property into the Family Trust and the Marital Trust (and the QTIP Trust, if applicable).
Ø File appropriate federal estate tax return and, if required, state estate tax return.
Ø File appropriate federal and state decedent final income tax returns.
Ø Re-title property into the separate name of the Family Trust and Marital Trust (and the QTIP Trust, if applicable).
BEYOND YOUR TAX PLANNING LIVING TRUST
If you are married with a common estate larger than $4 million or are a single person with an estate larger than $2,000,000, you may wish to consider additional estate tax planning options to further reduce or eliminate your estate tax liability. These options are in addition to your basic living trust plan. They do not replace it. Your revocable living trust should always be the foundation of your estate plan.
All of these additional options are “irrevocable” (they cannot be changed or revoked) once they have been set up. They all require you to legally give up ownership of your property, so think very carefully before you sign any irrevocable legal documents. Once you give your property away, it's gone forever. Remember: you cannot change your mind later on and take your property back even in the event that you need it, your financial situation has deteriorated, or catastrophic illness has occurred, etc.
Irrevocable options can be used to produce income for you and your family during your lifetime and to pass assets, free from estate taxes, to family or favorite charities while satisfying IRS requirements.
Here Are The Most Common Irrevocable Tax Planning Options
Ø Gifting
Ø Irrevocable Life Insurance Trust
Ø Family Limited Partnership
Ø Charitable Remainder Trust
Ø Charitable Lead Trust
Ø Charitable Contributions
Ø Grantor Retained Income Trust (GRIT)
You should know that estate tax planning beyond the basic tax planning living trust involves complex and constantly changing areas of the law. The IRS rules and reporting requirements are very technical and very strict. In addition, the IRS will very likely audit anyone using irrevocable options. Your plan must be properly set up or you can lose the tax savings and be assessed penalties and interest if the IRS audits and disallows your plan. This is definitely not a job for amateurs or general practitioners. Seek expert advice by consulting with an attorney or a CPA who specializes in estate tax planning and is thoroughly knowledgeable of the irrevocable options before you make any gifts or transfer your property into any irrevocable legal document. A specialist can evaluate your particular situation, explain your options, recommend the irrevocable plans most beneficial for your tax situation and make certain your plan satisfies IRS requirements.
Some Final Words On Estate Planning
Many people never do any estate planning because they get lost in the complexities of trying to understand every possible planning option. This is a difficult and frustrating approach that makes it very easy to procrastinate.
Plan your estate in a logical order - from basic to complex. Start with setting up a basic living trust (or tax planning trust) to completely avoid probate and reduce or eliminate federal estate taxes. Since a foundation living trust estate plan will handle most people's needs, you don't need to waste additional time collecting information about options that are not relevant to your situation.
It's very important that you take action now and set up your basic plan first so that you and your family will be protected. You can always "fine tune" your plan with one or more irrevocable options later on without affecting your foundation living trust plan.