There has been a lot of discussion regarding the advantages of having a living trust, especially in terms of avoiding probate. Probate can be a long costly process involving delays in gaining access to funds to pay bills and expenses, as well as making distributions of money and property to the heirs. Another topic that has been a recent focal point of discussion is the impending reduction in the estate tax exemption amount, coupled with an increase in the estate tax rate. Beginning January 1, 2013, the estate tax exemption will be reduced from $5.12 million to $1 million, while the estate tax rate on the excess (over the exempt amount of $1 million) will increase from 35% to 55%. The result is going to be a very large estate tax unless the law is changed in the near future.
Among its other advantages, setting up a living trust can provide a variety of opportunities to minimize overall estate taxes. One technique available to married couples involves the use of a credit shelter or bypass trust. Since husband and wife are two individuals, each spouse is entitled to receive the benefit of the exemption amount in place at the time of his or her death. Under a living trust, the exemption amount of the first spouse to die may be directed into a credit shelter or bypass trust that will pass free of tax upon the death of the second spouse. When the second spouse dies, his or her estate can not only exclude from taxes the exemption amount in effect at such time, but also the entire value of the credit shelter or bypass trust that was funded with the first-to-die spouse’s exemption amount.
Another advantage worth mentioning is that the credit shelter or bypass trust can still be a financial resource for the support of the surviving spouse, yet it is not included in the surviving spouse’s estate. Additionally, the assets in the credit shelter or bypass trust can increase in value and all of the appreciation will likewise avoid inclusion in the estate of the surviving spouse. Thus, setting up a living trust in this manner might end up shielding more than just the exemption amount of the first spouse to die assuming those assets have appreciated in value by the time the second spouse passes away.
When faced with the potential of a large estate tax, the above approach may be preferable to simply leaving everything to the survivor at the death of the first spouse. This is true even though one spouse can leave everything to the other spouse free of estate taxes due to the unlimited marital deduction. The downside of relying entirely upon the marital deduction to avoid taxes is that the exemption of the first spouse is entirely wasted and all of the couple’s money and property is taxed at the death of second spouse when only one spouse’s estate tax exemption remains available for use. Thus, planning with a living trust allows the couple to shield the maximum amount of money and property from estate taxes based upon the respective exemption amounts available to each spouse in his or her year of death.
Attorney Kari L. Stephens