An estate-tax planning technique often contained in many Trust agreements for married individuals is to require the establishment of two or more sub-trusts when the first spouse dies, in particular the establishment of an Exemption Sub-Trust. If the Trust agreement is properly drawn and the Exemption Sub-Trust correctly administered during the life of the surviving spouse, at the time of the death of the surviving spouse all of the assets of the Exemption Sub-Trust pass to the beneficiaries federal estate-tax free. This is true even though all of the income (and principal if need be pursuant to an ascertainable standard such as for health, education, maintenance and support) from the Exemption Sub-Trust is used for the benefit of the surviving spouse during his or her lifetime. The equivalent exemption amount for federal estate tax purposes for deaths occurring in 2012 is $5,120,000.00 and the tax rate is 35%, but as of January 1, 2013 the equivalent exemption for federal estate tax purposes for deaths occurring in 2013 and thereafter is reduced to $1,000,000.00 and the tax rate is increased to 55%. Accordingly, this estate-tax planning technique is of great importance.
When the first spouse dies, the Successor Trustees must determine what Trust assets should be used to fund the Exemption Sub-Trust. This is a very important determination in light of the fact that the Exemption Sub-Trust assets remaining at the time of the death of surviving spouse will not be subject to federal estate tax regardless of value. In other words, the Exemption Sub-Trust assets could be worth $20,000,000.00 at the time of the death of the surviving spouse and the equivalent exemption under law could be only $1,000,000.00, but nevertheless the assets of the Exemption Sub-Trust will not be subject to potential federal estate tax. Therefore, assets with high appreciation potential (i.e. Apple stock, real estate on the Las Vegas Strip, et cetera) generally speaking should be used to fund the Exemption Sub-Trust. But as is always the case, there is an exception to every rule. The exception is where the beneficiaries of the Exemption Sub-Trust and the beneficiaries of any other sub-trust are not one and the same individuals. In most situations, the beneficiaries will be the same. However, where the beneficiaries will not be the same, the Trustee has to consider this when funding the sub-trusts in that the Trustee has a fiduciary duty to treat all of the beneficiaries fairly and impartially in carrying out the terms of the Trust agreement. A corporate or individual Trustee could subject themselves to claims by non-beneficiaries of the Exemption Sub-Trust if in fact all of the assets with high appreciation potential are used to fund the Exemption Sub-Trust.
At the Jeffrey Burr law office, we have many years of experience assisting and advising corporate and individual Successor Trustees in the administration of a Trust after the death of a Trustor, including the funding of Exemption and other sub-trusts.