Federal Estate Tax

When drafting a trust, or planning for what happens to property after death, the taxpayer needs to be aware that all estates face tax issues. Federal and state laws must be considered. When studying federal laws, a taxpayer should pay attention to IRS administrative rulings.

The estate tax is a federal tax due when an individual dies and his/her property is given to heirs. In a trust, upon death, trust beneficiaries will be subject to estate taxes. The estate tax considers everything the deceased owned or had interests in at the date of death. The estate tax does not change based on whether the deceased transfers assets through will, trust, or state intestacy laws.

The gift tax prevents avoidance of the estate tax by giving away an estate before death.

However, there are personal exemptions from estate and gift taxes. There is no estate tax when a person leaves an estate to a spouse. This is because of the marital deduction. For gifts to individuals other than a spouse, the personal tax exemption applies. In 2009, estates with a value of $3.5 million could be left to other individuals without estate taxes. Reference to the federal estate tax can be obtained from www.irs.gov.

Some trust structures allow combining the individual tax exemption of a couple to save estate taxes when a second spouse dies. Such a trust is known as the AB Trust. Other names for the AB Trust are: bypass trust, exemption trust, family trust, credit shelter trust. AB Trust tax savings apply to married individuals only. AB Trusts avoid probate and provide estate tax savings.

An AB Trust uses the personal estate tax exemption of each spouse to maximize tax savings on the combined estate for heirs, such as children, of the couple. The structure of the AB Trust uses a shared living trust for both spouses and two additional trusts for each spouse, Trust A and Trust B.

If one spouse passes away, the spouse’s designated property of the shared trust goes into a new Trust A, which becomes irrevocable and provides the surviving spouse a lifelong interest in the trust assets. No trust assets are transferred upon the death of the first spouse to the other spouse. They remain in the
irrevocable Trust A.

The designated property of the surviving spouse goes into Trust B. Trust B stays revocable. The children of the married individuals are often nominated as second beneficiaries of the two trusts. As long as the surviving spouse does not change Trust B, according to trust terms, the children receive the trust assets of Trust A and Trust B.

As to the estate tax, the first transfer from the shared trust to Trust A is taxable because the marital deduction does not apply. Though, the personal estate tax threshold reduces or nullifies estate taxes. When the children become Trust A beneficiaries, there is no estate tax. Estate tax is applied on the assets of Trust B. Trust B is the trust of the surviving spouse. The personal estate tax threshold of the second spouse reduces or nullifies the estate tax on Trust B.

To learn more about estate and gift tax savings, consult with an experienced New York tax attorney.