In 2011, the Estate Tax is due to return with a 1 million dollar exemption (unified credit) and top tax rate of 55%. Without planning, this exemption is the same for both individuals and married couples. The following illustration explains how.
Married couples have an unlimited marital deduction to pass assets between each other1. Although useful during their lifetime, if their joint estate exceeds the unified credit, this could result in unnecessary estate taxes being paid upon the second spouse’s death. The following illustration explains how:
- Couple A and B have a joint estate of 2 million dollars
- Spouse A dies and spouse B inherits Spouse A’s half of the estate or 1 million dollars
- Spouse B dies and only the first 1 million dollars is protected2 by spouse B’s exclusion leaving 1 million dollars subject to the estate tax
- Assuming the maximum tax rate of 55%, the amount due in taxes is $550,000
Under this scenario, the first spouse’s estate tax exemption of 1 million dollars was wasted. So how can this be avoided?
The Marital Trust, sometimes called an A/B Trust, is used for a married couple that has a potentially taxable estate. The trust is designed to ensure the unified credit of the first spouse to die is not wasted. It effectively doubles the unified credit of married couples. Using the previous situation, the following illustration explains how the Marital Trust works:
- Couple A and B enter into a Marital Trust
- Spouse A dies and Spouse B’s half of the joint assets are retained by Spouse B and Spouse A’s half is placed into a Marital Trust or Credit Shelter Trust
- Spouse B retains access to the Marital Trust subject to certain broad limitations imposed by I.R.S. Rules
- Because of these limitations, Spouse B is not deemed to own Spouse A’s share thus using Spouse A’s credit and ensuring it is not included in Spouse B’s estate
- When Spouse B dies their 1 million dollars pass under their exemption while Spouse A’s share has passed outside of Spouse B’s estate
- All 2 million dollars pass to the beneficiaries of A & B free from tax thus saving up to $550,0002
This strategy only works up to double the amount of the unified credit. For additional amounts, or if you do not wish to use this strategy, you will need additional tax saving strategies.
1Receiving spouse must be a U.S. Citizen
2Assuming a Unified Credit of 1 million dollars