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Don’t
let the tax laws fool you. Currently the
law says the estate tax will be
eliminated in 2010. However,
·
The estate tax is scheduled to return to
pre-tax-cut levels a year later
·
Congress could take action before 2010
to keep the estate tax
·
Regardless, estates are subject to the
estate tax until 2010, and the amount of
assets subject to the tax is increasing
Currently, the law exempts $1.5
million of an individual’s assets from
estate taxes, and the amount is
scheduled to increase to $3.5 million in
2009. Unless Congress takes action,
though, the exemption will fall back to
$1 million in 2011.
By 2011, a fair number of
taxpayers will be millionaires on
paper. Anyone who wants to pass assets
on to heirs could be subject to federal
estate taxes of up to 55%, plus state
taxes, on assets exceeding the
exemption.
Fortunately, there’s an easy
way to double your exemption – by using
a credit shelter trust (CST).
It Pays To Be Married
The credit shelter trust
takes advantage of the unlimited marital
deduction, which, upon the death of the
first spouse, allows all assets to pass
to the surviving spouse free from estate
tax.
Here’s how it works: Upon
the death of the first spouse, the
applicable exclusion amount is typically
transferred from the estate of the
decreased spouse to the trust, which is
outside the taxable estate. In most
cases, the trust is drafted with the
surviving spouse as the trustee, which
gives the surviving spouse the right to
take distributions for health,
education, maintenance and support.
Upon the death of the second spouse, the
assets in the trust pass on to
beneficiaries free of estate tax.
Combined with the $1.5
million exemption that is preserved for
the second spouse, a total of $3 million
can be exempted from estate taxes.
It is essential that trust documents be
drafted properly, so be certain to
retain an attorney who is familiar with
trusts, and who understands income and
estate tax laws. Failure to do so could
result in adverse tax treatment of trust
proceeds.
CSTs and Life Insurance
Because assets in a CST are
exempt from estate taxes, it is
advantageous, of course, to maximize the
amount of assets in the trust.
Besides using the trust to
double the estate-tax exclusion, many
people leverage their trust assets by
setting up an irrevocable life insurance
trust (ILIT) and purchasing life
insurance inside the trust. Benefits of
purchasing life insurance inside a CST
include:
·
The death benefit from the life
insurance can be passed on to
beneficiaries tax-free.
·
Gift taxes are not triggered by the
purchase of life insurance.
·
Purchasing the life insurance can
greatly increase the wealth being passed
on to heirs without significantly
affecting cash flow.
·
Trust income tax will be less, because
life insurance is tax-favored.
·
As trust beneficiaries, children may
benefit from the cash value of the
insurance
·
If the trust is also set up as a Crummey
trust, which can be used to avoid gift
taxes, the paperwork that goes along
with it – sending out Crummey notices –
can be avoided.
Taking A Loan
The trust can also enter
into a fair-market loan arrangement with
an ILIT.
Here’s how it works: The CST
loans money to the surviving spouse’s
ILIT to purchase life insurance. The
interest rate on the loan should be
equal to or greater than the applicable
federal rate (AFR). The surviving
spouse gifts the interest to the newly
created ILIT and the CST makes the
premium and loan payment.
A fair market loan from a
CST may be an attractive strategy for
older clients who have an
estate-planning problem. The surviving
spouse can leverage the assets inside of
the trust and, at the same time, take
advantage of low interest rates. A loan
at fair-market rates does not have any
economic benefit costs, so the surviving
spouse does not need to plan for a
rollout, or termination of the loan
arrangement.
Technical Requirements
A CST can usually own life
insurance on the life of the surviving
spouse. However, the trust should not
own life insurance if it will cause the
surviving spouse to have incidents of
ownership with respect to the policy.
When establishing a Credit Shelter
Trust, be certain that the trustee has
the authority to purchase life
insurance. Also consider whether to
make the surviving spouse a trustee, as
well as a beneficiary. Finally, talk to
your attorney about special powers of
attorney, and five and five powers,
which allow the surviving spouse in a
CST additional flexibility to draw a
limited amount of funds from the trust
without taxation. The “five and five”
comes from the maximum amount that can
be used each year under this provision –
the greater of $5,000 or five percent of
the value of the trust principal.
A Credit Shelter Trust
should always be considered when
developing an estate plan, and should
not be overlooked when a surviving
spouse needs more estate tax protection
and is considering purchasing life
insurance. It can also be a tax
efficient source of income.
(Will Smith can be
reached at the Mid Atlantic Agency in
Raleigh.) |
