More On Tax Planningfrom The Advisor's Professional Library
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
- Cafeteria Plans The income tax treatment of cafeteria plans is key to their popularity. Learn how to maximize the tax benefits of these “flexible benefit plans”.
In December of last year, President Barack Obama turned the standard estate plan upside down when he signed the Tax Relief Act of 2010. In addition to a record $5 million applicable exclusion amount and continued 35% top rate, the estate tax included a brand new concept that may force your clients to re-evaluate their estate plan.
That concept is the Deceased Spouse Unused Exclusion Amount (DSUEA). In an earlier article, we concluded that the DSUEA not only makes bypass trusts unnecessary, but may even hurt an estate’s beneficiaries by reducing the basis of assets they receive from the bypass trust.
We hinted at one solution to the bypass trust problem—disclaimers. Here we’ll discuss a particular solution to the bypass trust problem, the so-called “A-B Bypass Trust.”
In general under the new estate tax, an estate’s applicable exclusion amount is the sum of two components: the basic exclusion amount and the DSUEA. The basic exclusion amount for estates of decedents dying in 2011 and 2012 is $5 million. The second part of the equation, the DSUEA, is the amount of the first-to-die spouse’s exclusion amount that is not used by the that spouse’s estate. Note that a surviving spouse’s DSUEA is equal to the unused exclusion amount of the surviving spouse’s last deceased spouse.
There is a very good reason to think twice before using a bypass trust in 2011 and 2012 (and in later years if the DSUEA concept sticks around for future estate tax acts). Assets of the first spouse to die that are placed in a bypass trust do not receive a step-up in basis at the death of the second spouse; however, assets that pass untaxed in the second spouse’s estate due to the first spouse’s DSUEA will receive a step-up in basis, which can result in a very significant income tax savings when beneficiaries of the surviving spouse’s estate sell property received from that estate.
But that isn’t to say that the Marital Deduction/Bypass Trust combo (also called A-B Trusts) isn’t ever appropriate in light of the new estate tax. A-B Trusts can be used for purposes other than estate tax planning, including protecting trust assets from the surviving spouse’s creditors and offering the first spouse to die a degree of control over the final disposition of trust assets. As a result, a number of your clients may not be interested in disturbing their current trust arrangement.
If the standard A-B Trust is generally obsolete for estate tax planning purposes, is it necessary to start from scratch with an estate plan?
Fortunately, no. Fixing the problem can be as simple as amending and restating the original trusts as an A-B Disclaimer Trust. If the trusts are revocable living trusts that are currently in existence, assets owned by the trusts will not need to be retitled.
Before discussing the A-B Disclaimer Trust it’s important to make clear how it will differ from the standard A-B arrangement. Under the standard A-B arrangement, the B trust will become irrevocable when the first spouse dies. This will lock in the terms of the trust and generally pay only income to the surviving spouse—who will have little to no access to B-trust principal.
In contrast, the A-B Disclaimer trust puts the power over all the trust assets into the hands of the surviving spouse. If your clients desire the terms of their estate plan to freeze on the death of the first spouse to die, it may be appropriate for them to retain their original trusts. That’s a question for their legal counsel.
If the surviving spouse’s control and access to all trust assets isn’t an issue, the A-B Disclaimer Trust may be a solution to the basis problems created when the standard A-B Trust interacts with the new estate tax.
What the A-B Disclaimer Trust does is give the surviving spouse the power to decide not to fund the B trust. He or she will have nine months from the spouse’s death to make that decision. If the surviving spouse chooses not to fund the B trust he or she will have to rely on the DSUEA to utilize the first-spouse-to-die’s applicable exclusion amount. There is always a chance that the DSUEA will disappear at the end of 2012.
The A-B Bypass Trust arrangement can also be appropriate where a couple’s estate may not be hit with the estate tax at all. For instance, a couple with an estate just south of $5 million won’t be hit with the estate tax if the 2011-2012 exclusion amount is retained past 2012.
In that case, the A-B Trusts are unnecessary and the surviving spouse is likely to elect against funding the B trust. But if the exclusion amount is allowed to drop back to $1 million, they may have significant estate tax exposure and may need the full A-B Trust structure. In that case, the surviving spouse can elect to fund the B Trust.
Although the A-B Disclaimer Trust is appropriate for many couples, as we indicated earlier, its utility will depend on the clients’ estate planning objectives. Although legal counsel will be needed to revise the trusts, the expense likely won’t be as high as if the trusts needed to be redrafted from scratch.
For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s partner, AdvisorFX, for a free trial.
See also The Law Professor's blog at AdvisorFYI.