Estate Planning and Trusts (tjmf-18510)

If you own property or assets of substantial value and have not yet thought about estate planning, it is time to start doing your calculations in order to put a plan in place. If you die having property, the state levies tax on your estate. As of 2007, property worth two million or above is taxed. Whoever is the recipient of your assets has to pay a hefty amount in estate taxes, which may be up to 45 percent of the value of the estate left behind by you. Thus, if you do not have an estate plan, it may lead to a considerable part of the assets you leave behind being soaked up in taxes instead of going to your loved ones.

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Estate planning consists of using effective methods to ensure that the estate tax implications are minimized after you death, and that the major part of your property/assets passes effortlessly to the recipients. Forming a bypass trust can be an effective way to reduce estate tax.

This can be better understood with an example. Suppose a husband and wife, Tom and Linda, jointly possess assets worth around $4.5m. If Tom dies first, Linda gets all of the assets of Tom without having to pay any estate taxes by virtue of the provision of unlimited spousal estate tax exclusion. The assets of Linda would be valued at $4.5m thereafter. If Linda dies later, in the same year, when the estate tax rates are the same, assuming there has been no appreciation in the value of her estate, her estate tax on $4.5m would amount to $1, 905,800. Accordingly, her estate would be taxed $1,125,000 (after allowing an estate tax credit of $780,800), which her heirs would have to pay up. Since Linda availed unlimited spousal estate tax credit on the death of Tom, his estate tax credit of $780,000 stands extinguished. (The flat credit of $780,000 on estate tax liability is allowed against the exemption limit of $2m for 2007.)

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Now let us see the difference if Tom and Linda had created a bypass trust through a revocable living trust (also called a family trust). A trust can be loosely defined as a legal entity capable of owning property and other assets. Every trust has a grantor, also called a creator or settler, who grants property to a trustee. The trustee cares for and uses the property for a third person or beneficiary. In a trust, a single person can take on many roles. In a revocable living trust, Tom could have been the grantor, trustee, and beneficiary, all at the same time. The trustee is bound to act in strict accordance with the terms of the trust in handling the trust property. In the event of the death of Tom, the owner, i.e. the trust, still survives. So there is no question of probate proceedings arising, and a new successor to the deceased trustee can smoothly take over.

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To minimize estate tax, the revocable living trust can contain a provision that on the first death, of either Tom or Linda, a second or bypass trust would be formed. So, in the event of the death of Tom, $2m (equivalent to the estate tax credit for Tom) out of the $4.5m would be transferred to the bypass trust. In such an eventuality, the bypass trust acquires its own identity and irrevocable status, and thereafter would file its own tax returns. The assets of this bypass trust are used for the welfare, heath, upkeep, and maintenance of the surviving spouse, and after the second death, would be available for the subsequent beneficiaries.

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Therefore, on the death of Tom, Linda would get the remaining $2.5m without paying any taxes, on account of the unlimited spousal estate tax exclusion. On the death of Linda, the bypass trust and Linda being separate entities, the value of the bypass trust assets would not be taken into consideration to assess the estate tax of Linda. Thus, the estate tax assessed on the estate of Linda at $2.5m, after deducting the estate tax credit of Linda, would come to just $225,000 as against $1,125,000 in the absence of a bypass trust. This is a clear saving of $900,000.

There are other types of trusts that serve the same purpose for other situations. (All figures are approximate, and relate to 2007).

About the author: Former IRS Agent offers California Estate Planning. CPA Firm Murrary and Young offers expert accounting consultation to those in and around the California Area. Visit http://www.april15.com