By: Investor Solutions
For some families, an estate plan that transfers all of the assets to a surviving spouse could be the very worst possible approach. You could unwittingly build in a future estate tax problem, lose control of the final disposition of the assets, and fail to provide a management structure for your survivors. But, there are simple solutions that allow you to maximize the benefit of an unlimited marital deduction and solve all these problems.
The Unlimited Marital Deduction is a powerful estate planning tool that allows the first to die spouse an unlimited estate and gift tax free distribution of assets to his or her spouse. There are different types of marital trusts that allow for the use of this deduction. When properly used, in conjunction with the applicable exclusion amount ($2,000,000 in 2006), a significant amount of wealth can pass to a surviving spouse estate tax-free.
Outright Transfers to Spouse Perhaps the most obvious way to provide for your spouse and make use of the unlimited marital deduction is to leave your assets outright to your spouse. Although this technique may be fine for a couple with few assets (less than $2,000,000 in total in 2006) and only each other to care for, it is not the optimal solution for most people. By leaving your assets outright to your spouse, you lose advantage of the applicable exclusion amount, increase the estate tax due at your spouse’s passing and relinquish post mortem control of your assets. For these reasons, the use of trusts has gained popularity as an effective estate planning tool. Credit Shelter or Bypass Trust Before we talk about the different types of marital trusts, let’s discuss credit shelter trusts. Also called non-marital, “B”, non-marital B, bypass, family, unified credit and unified credit shelter trusts, this trust is funded with property transferred upon the decedent’s death. Typically, the amount transferred to the trust is equal to the applicable exclusion or $2,000,000 in 2006. The trust language can be such that it provides for lifetime income to a surviving spouse only or to the surviving spouse and other individuals. The decedent maintains postmortem control of the property by ultimately designating how the trust’s corpus will be distributed. Upon termination of the trust or death of the surviving spouse, the trust’s assets will pass estate tax free according to its terms. What follows is a discussion of the different marital trusts available and their more common uses.
Qualified Terminable Interest Property Trust (QTIP)- Sometimes referred to as the “current income” or “C” trust, the QTIP trust is used to provide a surviving spouse with income for life while the decedent maintains control of the trust’s assets even after the second spouse passes. Depending on the terms of the trust, distributions of principal may be allowed. The property transferred to the trust can qualify for the unlimited marital deduction upon the first death but must be included in the gross estate of the second to die spouse. It is possible to use the second spouse’s unified credit to further shelter these assets from estate tax. In order for the property to qualify as QTIP property, the decedent’s estate must make that election on Schedule M of the decedent’s Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. QTIP trusts are typically used by individuals who are on their second marriage but have children from a previous marriage they want to continue to provide for.
Power of Appointment Trust Also known as the “A” or “Marital A” trust, the Power of Appointment Trust is one in which the surviving spouse has either a lifetime or testamentary general power of appointment over the property. Unlike with a QTIP trust, the surviving spouse has postmortem control of the trust assets and can transfer or dispose of them as he or she deems appropriate. The surviving spouse also has the right to all of the income and authority to invade the corpus. Property transferred to the trust is included in the decedent’s gross estate but is not subject to the estate tax because it qualifies for the unlimited marital deduction. The property must also be included in the gross estate of the surviving spouse and may be protected from estate taxes by way of the applicable exclusion.
Qualified Domestic Trust (QDOT)
In most instances, property passing to a surviving spouse qualifies for the unlimited marital deduction. However, the exception to the rule is property passing to a non-U.S. citizen spouse from a U.S. citizen spouse. In order for property passing to a non-U.S. citizen spouse to qualify for the deduction, the property must pass to a Qualified Domestic Trust. This trust allows for the surviving spouse to receive income for life but not principal. This is done so as to avoid the surviving spouse from removing the assets from control of a U.S. taxing authority. In order to qualify as a QDOT, certain requirements must be met. These include, an election must be made by the executor, at least one trustee must be a U.S. citizen or domestic corporation, all income must be payable to the non-citizen spouse and a U.S. bank must serve as trustee for trusts with over $2 million in assets. Like a QTIP election, a QDOT election is made by listing the trust property on Schedule M of the decedent’s Form 706 and deducting its value. A QDOT and QTIP election are both irrevocable.
An Estate Trust typically holds non-income producing property as it does not provide the surviving spouse with a lifetime income stream. It is rarely used except in instances where the surviving spouse will not need additional income from the trust.
A trust is an excellent estate planning instrument that allows for execution of a decedent’s wishes even after his or her passing. Discuss these and other estate planning issues with your legal counsel prior to making any decision to ensure that it is the right tool for you.