All U.S. taxpayers have the benefit of an exemption equivalent, which is often still referred to as the unified tax credit. This allows individuals to make lifetime gifts and transfers at death of property valued up to certain amounts. It works in the form of a credit, taken on client tax returns, against taxes that would otherwise be assessed on gifts and estate transfers.

Even though it is treated as a credit, for planning purposes it is often discussed in terms of the dollar amounts that the exemption shelters. For 2003, the maximum amounts for both gift and estate taxes are set at $1 million. Over the course of this decade, the credit available for transfers at death is scheduled to slowly increase, in steps, up to $3 million, while the lifetime gift amount will remain at $1 million.

This exemption against gift and estate taxes is a central part of virtually every written estate plan and is used for a wide variety of estate planning techniques. Many advisors recommend that clients make lifetime gifts into irrevocable trusts set up to maximize this exclusion. By transferring assets into a trust intended to maximize the exemption amount, clients can shelter the assets and all future growth from future estate and gift taxes.

The exemption is particularly valuable to married couples. Even though a lifetime transfer of assets into these trusts often makes sense, most clients hold onto this exemption amount until their death. Even with this delay, the exemption still can be valuable. Many estate plans allow for assets to be segregated into a trust using this exemption after the death of the first spouse. If these assets werent set aside into this trust, the deceased spouses exemption would be wasted. By funding a trust up to the exemption equivalent amount ($1 million for this year), those assets and all growth are protected from future estate taxation.

On the death of the surviving spouse, they can shelter some or all of their remaining assets with the use of their own exemption. With proper planning and with proper titling of assets, a husband and wife can shelter up to $2 million of assets from estate taxes at their deaths.

These trusts are commonly called Credit Shelter Trusts, although they are also known under a variety of other names. Some other common names are the By-Pass Trusts, because once funded amounts in these trusts bypass the survivors estate, or Family Trusts, the funds can be made available for the surviving family or spouse. Under most arrangements involving these types of trusts, they ultimately terminate at the death of both spouses, resulting in a distribution of the assets to the trust beneficiaries.

Chart Two shows how this technique helps a married couple. Couple A had $2.5 million but did not do any planning with their exemption equivalent. No estate taxes were paid on the death of the husband (in this example, the first to die), because of the unlimited marital deduction. His exemption wasnt used and all of his assets passed to his wifes ownership.

On the wifes death (the second to die), she could only use her exemption of $1 million. Although their children inherited $1.82 million, it was far less than they might have received as compared with Couple B.

Couple B also started with $2.5 million, but they set up and used a credit shelter trust on the death of the first spouse. Assuming the husband again was the first spouse to die, at his death $1 million was placed into a credit shelter trust for the benefit of his surviving wife and family. Then, on the wifes death she was also able to use her own $1 million exemption equivalent. Even though they began with the same $2.5 million, their children inherited $2.29 million, or $470,000 more simply due to this planning.

–Mark A. Teitelbaum


Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.