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A revocable trust can naturally be changed. The relevant probate code section provides "unless the trust instrument provides otherwise, if a trust is revocable
by the settlor, the settlor may modify the trust by the procedure for
revocation." Prob C
§
15402. Interestingly, an irrevocable trust can also be changed. Although it is not as easy to modify an irrevocable trust.
The probate code provides various methods in which an irrevocable trust can be modified. One method that has become increasingly popular is modification on the grounds of "changed circumstances." This law is found in Prob C § 15409. It provides:
(a) On petition by a trustee or beneficiary, the court may modify the
administrative or dispositive provisions of the trust or terminate the
trust if, owing to circumstances not known to the settlor and not
anticipated by the settlor, the continuation of the trust under its
terms would defeat or substantially impair the accomplishment of the
purposes of the trust. In this case, if necessary to carry out the
purposes of the trust, the court may order the trustee to do acts that
are not authorized or are forbidden by the trust instrument.
(b) The court shall consider a trust provision restraining transfer of the
beneficiary’s interest as a factor in making its decision whether to
modify or terminate the trust, but the court is not precluded from
exercising its discretion to modify or terminate the trust solely
because of a restraint on transfer.
The principal reason why the "changed circumstances" avenue is more available now is because of the immense growth in the estate tax exclusion amount. The chart below displays the exclusion amount from 2001 - 2015.
Year Amount Excluded Maximum Tax Rate
2001 $675,000 55%
2002 $1M 50%
2003 $1M 49%
2004 $1M 48%
2005 $1M 47%
2006 $2M 46%
2007 $2M 45%
2008 $2M 45%
2009 $3.5M 45%
2010 Repealed 0%
2011 $5M 35%
2012 $5.12M 35%
2013 $5.25M 40%
2014 $5.34M 40%
2015 $5.43M 40%
Many people in the 1990s and 2000s were (rightly) under the belief that their estate would be subject to the estate tax. Thus they would execute what is commonly referred to as an A/B Trust to maximize the amount that could be shielded from the estate tax. However, since the estate tax exclusion amount has risen substantially, many couples do not need an A/B Trust.
The problem is that in a A/B Trust situation, upon the death of the first spouse to pass away, the split of the marital estate into two separate trusts, an A Trust and B Trust, is mandatory. Thus, there is the creation of an irrevocable trust when one spouse passes away, the B Trust. However, the B Trust's main purpose is to minimize the estate tax. If the estate tax is not an issue, then the B Trust loses much of its importance. Therein lies where a petition under Prob C § 15409 to eliminate the B Trust comes into play. Typically, the surviving spouse will ask a probate court to order that the B Trust be terminated because of the changed circumstances. Although in a case I had both parents were deceased and the successor trustees sought to eliminate the B Trust.
1. What is the Estate Tax limit in 2013?
The applicable exclusion amount in 2013 is $5M plus inflation.
2. What does this mean?
If an estate is valued at less than or equal to $5M, the Estate Tax will not be applied to the decedent's estate. However, if the decedent's estate exceeds $5M, then the Estate Tax will apply albeit only in regards to the portion above $5M.
For example, Danny Decedent died on New Year's day 2013 in a tragic hot air balloon accident. Danny's entire estate consisted of a $6M bank account because of his miserly ways. Since Danny's estate exceeded the applicable exclusion amount in 2013, $5M, the Estate Tax would apply to the excess, namely $1M. However, if Danny's estate was worth $4.5M, no Estate Tax liability would arise because it does not exceed the applicable exclusion amount.
3. What was the Estate Tax limit in 2012?
The Estate Tax limit in 2012 was $5.12M
4. Which year applies to a decedent's estate?
The applicable year is the year in which person passes away. The chart below summarizes the following years' Estate Tax regime. Consequently, if a person died in 2002, the $1M exclusion amount would apply or if a person died in 2007, the $2M exclusion amount would apply.
Of note, it does not matter when a person writes their will or trust. I have been asked this question numerous times. Some people are under the impression that the year in which the decedent wrote their testamentary document controls. This is simply not true. I give them credit for creative thinking though. A trust written in 1985 by a 2005 decedent results in the application of the 2005 Estate Tax law, not the 1985 Estate Tax law.
As you can see by the below chart, the applicable exclusion amount has increased tremendously recently. In particular, the rise in the applicable exclusion amount easily outstrips inflation over this time.
Year Amount Excluded Maximum Tax Rate
2001 $675,000 55%
2002 $1M 50%
2003 $1M 49%
2004 $1M 48%
2005 $1M 47%
2006 $2M 46%
2007 $2M 45%
2008 $2M 45%
2009 $3.5M 45%
2010 Repealed 0%
2011 $5M 35%
2012 $5.12M 35%
2013 $5.25M 40%
5. What is included in a decedent's estate?
Any personal, real or intangible property the decedent owned wherever located. In other words, everything you own basically. IRC §2031(a). There are other categories of items included in a gross estate but are too technical to explain succinctly.
6. What is not included in a decedent's estate?
Real property earmarked for a qualified conservation easement. IRC §2031(c).
7. When is the Estate Tax due?
The Estate Tax return must be filed 9 months after the decedent's death unless an extension is granted. IRC §6075(a). The form used is IRS Form 706.
8. Can I get an extension?
Yes, a 6-month extension is automatically granted upon request. Treas Reg §20.6081-1(b). However, this does not extend the time to pay the tax. Generally speaking, the Estate Tax must be paid when the return is filed. IRC §6151(a).
9. What is the Estate Tax's top rate?
The maximum rate in 2013 is 40%.
10. Will California have an Estate Tax in 2013?
No, legislation recently passed by Congress to avoid the "fiscal cliff" eliminated the state Estate Tax credit. Therefore, there will be no California Estate Tax in 2013.
One of the key terms used when discussing the estate tax is the "marital deduction." The Internal Revenue Code provides an enormous deduction for transfers to the surviving spouse from the deceased spouse. This post will provide a brief overview of the marital deduction.
The estate tax is applicable to all U.S. citizens and permanent residents when they die. Still, the estate tax is levied upon only certain estates that exceed a monetary threshold. The threshold figure for 2012 is $5.12M. This means that if a person's estate is valued over $5.12M, an estate tax of 35% will be levied upon the amount over $5.12M. For example, if a person's estate is worth $6M, a tax would levied upon 880,000. If a person's estate is under the threshold, there is no estate tax.
The value of a person's estate is basically the computation of all assets the person owns worldwide. Hence, if a person is a U.S. citizen but owns property abroad, e.g. a London flat, this flat would count towards the estate tax calculation. However, deductions from the value of the person's estate are permissible and therein the marital deduction comes into play.
A deceased spouse may transfer to a surviving spouse an unlimited amount of assets so as to reduce the value of their estate for estate tax purposes. IRC §2056(a). Although in practice the size of the transfer is typically carefully calculated to avoid future problems. For instance, if an affluent husband transfers his entire estate worth tens of millions of dollars to his surviving wife, the wife will probably have an estate tax issue down the line. This is due to the fact that the wife, assuming she does not re-marry, will not have the marital deduction at her disposal when she passes away. The upshot is that if a wealthy spouse blindly leaves everything to the surviving spouse, the estate tax issue is not really addressed but delayed.
The common arrangement when dealing with marital deduction is to utilize the estate tax exemption of the deceased spouse by sheltering or disclaiming said amount and leaving the remainder to the surviving spouse. This sounds perplexing at first blush but is not conceptually difficult. Assume John Doe has an estate worth $8.12M. He marries Jane Doe in 2012 in a May-December wedding. Jane is a U.S. citizen. Prior to John's passing, the couple write a marital deduction trust. The trust says that upon John's death, the trustee shall allocate to the marital deduction trust the maximum amount allowed to pass tax-free under the estate tax, i.e. the applicable exclusion amount. The remainder shall be allocated to Jane's trust. When Jane passes away, both trusts are to be distributed to John's neighbor Wilbur Wright. When John passes away in 2012, the trustee allocates $5.12M to the marital deduction trust and $3M to Jane's trust. Shortly thereafter in 2012, Jane passes away. Since Jane's estate is less than the estate tax threshold, $3M is less than $5.12M, and John's estate is held by a marital deduction trust, the estate of $8.12M passes to Wilbur estate tax-free. In short, since the couple wrote a marital deduction trust, the couple was able to utilize the unique advantages couples have in regards to the estate tax. That is, the couple was able to shield millions of dollars in assets from the estate tax due to drafting a marital deduction trust.
There are caveats for utilizing a marital deduction trust however. The primary concern is that the recipient spouse must be a U.S. citizen. Conversely, there is no requirement that the deceased spouse be a U.S. citizen or a resident.
Another key caveat is that marital deduction is not available to same-sex couples or domestic partners. While the Internal Revenue Code defers to state law for the definition of a spouse, the Defense of Marriage Act ("DOMA") prohibits the IRS from relying on a state law definition of spouse when the state law treats a same-sex couple or domestic partners as spouses. 1 USC §7. Although various courts have invalidated DOMA on constitutional grounds. Furthermore, here in California, the 9th Circuit affirmed a district court ruling that struck down Prop 8, the California constitutional amendment to ban same-sex marriage that passed in 2008. Going forward, the Prop 8 case, along with other DOMA cases, makes the future of DOMA uncertain.
The following is an excerpt from a recent California Court of Appeal decision:
"Before Beckwith presented the will to MacGinnis, he called Dahl to tell
her about the will and e-mailed her a copy. Later that night, Dahl
responded to Beckwith's e-mail stating: `"I really think we should look
into a Trust for [MacGinnis ]. There are far less regulations and it
does not go through probate. The house and all property would be in our
names and if something should happen to [MacGinnis] we could make
decisions without it going to probate and the taxes are less on a trust
rather than the normal inheritance tax."
Beckwith v. Dahl (2012) ___ CA4th ___
The phrase in italics is a common fallacy held by many people. A revocable trust is a tax neutral document, i.e. it will neither increase nor decrease taxes. Dahl was acting under this erroneous belief when she emailed Beckwith above. Regardless if the decedent wrote a will or revocable trust, the taxation of their estate would be unaffected by the drafting of either instrument. The principal reason for this is because reducing or eliminating the estate tax, "inheritance tax" is a colloquialism, is determined by the recipient of the property, e.g. a spouse or a charity, as opposed to what instrument is used.
However, it should be noted that other types of trusts are created to avoid or reduce taxes. For example, a disclaimer, A/B and charitable trusts are all examples of trust specifically designed for such. Still, each of these trusts utilize beneficiaries that are considered allowable deductions for estate tax purposes. For example, if a person passes away with a $100M estate, they can devise it entirely to charity and their estate will not have any estate tax liability.
The following are some common reasons why a person decides to write a will and/or trust.
Avoid probate
This is probably the most common reason why a person writes a trust. Probate is the court-supervised transfer of assets from a decedent to a beneficiary or beneficiaries. The three main components are (1) the collection of the decedent's assets, (2) the satisfaction of the decedent's debts and (3) the distribution of the remaining assets to the beneficiary or beneficiaries. For example, if the decedent was a resident of Alturas, CA, their estate would be probated, if applicable, in the Modoc County courthouse as shown above.
Of note, a will does not avoid probate as all wills are ultimately probated. Although, if the estate is not large enough, the will does not go through the formal probate process. Instead the will is merely lodged with the probate court. Prob C
§
8200. This is the case when a person writes a "pourover will" in which the person's trust essentially owns almost the entire estate whereby no formal probate is needed. I have done this a few times for deceased clients.
The two main reasons why a person would want to avoid probate is simply time and money. First, probate takes a minimum of approximately 6 months to complete, though the normal completion time is 9-12 months. The added completion time is dependent upon the court's docket. The less-clogged the probate calendar, the faster probate can be completed. Second, probate fees are particularly high. The fee is determined by taking a percentage from the estate's value. The fee is progressive such that the higher the estate's value, the larger the probate fee for the personal representative and attorney. The personal representative is always free to waive compensation, though the attorney is probably not as likely to do so.
Avoid estate taxes
The most commonly read post on my blog is the one devoted to the estate tax. Since I wrote the article on December 27, 2010, it has been uniquely viewed 11,966 times according to Google Analytics. The average time on the page for a visitor is 3 minutes 53 seconds. For whatever reason, many people believe that the tax man, also known as the IRS, will come knocking on their door once the grim reaper has blown through. This is largely fantasy thinking. The estate tax affects a few small number of individuals. For example, the estate tax threshold in 2012 is $5,120,000. This means that if your estate is under that amount, your estate will owe no federal estate taxes. In case you were wondering, California does not have an estate tax for 2012. Individuals with estates that large are few and far between. Still, I am aware that the estate tax limit is set to revert back to the $1M threshold for 2013 if no legislative action is taken. In which case, thousands of individuals would be affected that were previously exempt from the estate tax. Regardless, millions of people will remain unaffected by the estate tax if it is lowered to a $1M threshold.
Nonetheless, various trusts can be set up to avoid or delay the application of the estate tax. For instance, an A/B trust, Disclaimer trust, charitable remainder trust and a QDOT trust are all examples of trusts specifically designed to accomplish such.
Provide for the smooth transition of assets from decedent to beneficiary
If a person writes a will and/or trust they are removing the legal system's distribution scheme from the equation, known as intestate succession. In California, the probate code specifically spells out how assets are distributed to heirs. For example, if a single person passes away who does not have children or grandchildren, their assets would be distributed to their parent(s), and if no parent is living, then the assets would be distributed to their brothers and sisters. If you ever want to see what the breakdown is for your heirs, just look at a table of consanguinity (Google it). A common problem that arises when distribution is left to intestate succession is the fact that the personal representative must track down the heirs, wherever they may be. Another problem with intestate succession is that only your relatives can inherit your estate, friends are not included. Thus, if a person was estranged from their family but had a number of close friends, upon that person's death his estate would be distributed to his family unless he wrote a will, trust or designated beneficiaries through non-probate means. Moreover, a surviving boyfriend or girlfriend would not be entitled to anything under the laws of intestate succession.
An additional benefit for writing a will and/or trust is the fact that a person can stipulate the terms of the inheritance. A few clients have expressed a concern that their children were not as responsible as they desired. The fear was that the child would inherit the money and immediately engage in frivolous spending given their spendthrift mentality. For example, a guardianship of the estate for a minor automatically terminates at age 18, the age of majority in California. Prob C
§
1600(a). Thus, the spendthrift child's inheritance, if in a guardianship, would have no spending limitations placed on it post-18. The child would then be free to spend as they see fit. In light of this, a trust established for a child's benefit can specify its purpose. Many trusts often state that the trust will be used for health, education, maintenance and support. The key is that the trustee, rather than the child, will ultimately make the determination as to trust distributions and allocations. Yes, this scenario does create a "trust fund baby" situation, although I would prefer that to a situation where the child spends the money on frivolous items.
The following are some myths I have seen that are related to living trusts.
Fiction: Writing a living trust will, by itself, avoids estate taxes for the decedent’s estate
Fact: Writing a living trust only allows a person to reduce or eliminate estate taxes. In order to reduce or eliminate estate taxes, a person needs to take affirmative steps. For example, assume that husband and wife establish an A/B trust in 2007. At the time of the husband’s passing in 2011, the estate is worth $8M. For reference, the estate tax in 2011 is $5M. Even though husband and wife wrote an A/B trust, wife will need to take affirmative steps to eliminate the estate tax by funding her husband’s B trust with the estate tax exemption amount, $5M, and then allocating the remainder to her trust, the A trust. In sum, simply because husband and wife wrote an A/B trust does not mean that an estate tax issue is resolved.
Fiction: Assets held in a revocable trust do not count towards the resource threshold for Medi-Cal eligibility.
Fact: If a trust is revocable, the assets of the trust are considered an available resource for the Medi-Cal applicant. 42 USC §1396p(d)(3)(A); 22 Cal Code Regs §50489.5(e); Medi-Cal Eligibility Procedures Manual (MEPM) Letter No. 192 (Dec. 18, 1997), 9J-73. However, assets held in a testamentary trust for the Medi-Cal beneficiary do not count towards eligibility requirements. 42 USC §1396p(d)(2)(A); 22 Cal Code Regs §50489.5(a)(1). For reference, a testamentary trust is a trust created at someone’s death for the benefit of another person. Conversely, a revocable trust is one created during someone’s lifetime that benefits them.
Fiction: A non-attorney, as trustee of a trust, can sue on behalf of the trust.
Fact: A non-attorney trustee cannot litigate on behalf of the trust in propria persona against a third party. Ziegler v Nickel (1998) 64 CA4th 545. For example, if a trust owned a vacant lot and a person routinely trespassed on the vacant lot, a non-attorney trustee would be required to hire an attorney to prosecute the trespass action. This is similar to legal action taken by a corporation, in that a corporation must be represented by an attorney in court as well.
Fiction: An irrevocable trust can never be modified.
Fact: Even though it sounds logically inconsistent, California law permits an irrevocable trust to be modified in the following circumstances: all beneficiaries consent (Prob C §15403); all beneficiaries and the settlor consent (Prob C §15404(a); at least one beneficiary and the settlor consent (Prob C §15404(b); principal is uneconomically low (Prob C §15408); there are changed circumstances (Prob C §15409); and to conform the trust to tax laws.
Fiction: A trust can last forever.
Fact: Only certain trusts can last forever. For example, a charitable trust may last forever provided there are ample funds. Prob C §21225(e). Conversely, a non-charitable trust will most likely last at most 90 years because of the Uniform Statutory Rule Against Perpetuities. Prob C §21225(b).
Fiction: The signatures that execute a trust require notarization.
Fact: There is no California law that says that a trust has to have notarized signatures. However, no competent attorney will allow a client to sign a trust without a notary present because it is best practice.
Fiction: Attending a living trust seminar is always a good place to find answers about trusts.
Fact: Living trust seminars are often facades to sell annuities to unsuspecting victims. The organizers of these seminars, known pejoratively as "living trust mills", are usually insurance agents, not attorneys, who use the allure of a trust as a Trojan horse to peddle annuities. This lawsuit filed by the California Advocates for Nursing Home Reform succinctly summarizes the scam that is perpetrated by these living trust mills.
The following are some questions that relate to a disclaimer trust.
1. What is a disclaimer?
A disclaimer is basically a refusal to accept an interest in property via inheritance.
2. What is a disclaimer trust?
A disclaimer trust is a type of trust where a disclaimant, often the surviving spouse, disclaims property from the deceased person’s estate, whereby the disclaimed property is transferred to a disclaimer trust.
3. Why would I use a disclaimer trust?
Disclaimer trusts are used by couples to take advantage of the marital deduction formula that cushions the blow of the estate tax.
4. How does a disclaimer trust work?
First, the surviving spouse will disclaim a certain amount of property from the deceased spouse’ estate which will be held in the disclaimer trust. Then, the surviving spouse may make distributions to themselves from the disclaimer trust "if the power is subject to an ascertainable standard." Treas Reg §25.2518-2(e)(1). This ascertainable standard is generally thought to be limited to health, maintenance, or support. Treas Reg §25.2518-2(e)(5), Example 12. The disclaimer trust will most importantly not be considered an asset of the surviving spouse’s estate for estate tax purposes but instead the deceased spouse’s estate.
The following example should offer guidance:
Harry and Wendy, a mature married couple, resided in lovely Campbell, California. Harry and Wendy had two children, Sampson and Donna. Harry passed away in 2011 in a tragic hot air balloon accident. At such time, the marital estate was worth $7M. Prior to Harry’s passing, the couple executed a marital trust in which the survivor would inherit the decedent’s entire estate subject to a disclaimer trust.
The sole assets of Harry and Wendy were a home worth $5M and $2M in Google stock. Since Wendy was a frugal person, she believed that she would be unable to exhaust the entire marital estate, namely $7M, before she passed away. Of note, if Wendy did pass away in 2011 or 2012 and her estate was greater than $5M, her estate would be subject to the estate tax.
Wendy decided to disclaim her entire interest in the Google stock, specifically $2M, through the medium of a disclaimer trust in order to avoid the potential implication of the estate tax. The result of Wendy’s disclaimer would create 2 trusts, a survivor’s trust for Wendy and a disclaimer trust for Wendy as well. Wendy could use the survivor’s trust for any purpose she wanted whereas the disclaimer trust could be used for matters involving an “ascertainable standard” as mentioned earlier. For instance, if Wendy was in need of a hip replacement surgery, she could distribute a portion of the disclaimer trust, namely Google stock dividends, to herself to pay for the surgery because it was a medical expense.
Furthermore, Wendy’s disclaimer would appreciably benefit her children, Sampson and Donna, because the assets of a disclaimer trust would not be included in her estate for estate tax purposes. Thus, even though Wendy’s two trusts might total over $5M, the estate tax exemption amount for 2011 and 2012, her estate would not subject to the estate tax. The reason for this is because the disclaimer trust would be considered part of Harry’s estate and the survivor’s trust would be part of Wendy’s estate. Therefore, Wendy’s children would reap a significant tax savings thanks to Harry and Wendy’s prudent planning.
5. Is a disclaimer trust an irrevocable trust?
Yes, a disclaimer trust is an irrevocable trust.
6. Can I make an oral disclaimer?
No, federal and California law requires that a disclaimer be in writing. IRC §2518(b)(2); Prob C §§265, 278.
7. Is a disclaimer trust comparable to an A/B trust?
Yes, a disclaimer trust is a document that seeks the same goal as an A/B trust, avoidance of the estate tax to the fullest extent possible through a marital deduction formula.
8. What type of people use disclaimer trusts?
The disclaimer trust is designed for people with an estate where the estate tax might be an issue. An A/B trust is geared towards couples where the estate tax will be an issue.
Unfortunately, nobody knows the estate tax’s long-term future given that the current law is set to expire in 2013.
9. How do you value assets that might or might not be disclaimed?
The value of the asset is the fair market value of the property on the date of death. IRC §2031(a). For example, if James purchased a home for $300,000 in 1985 and died in 2011 when the home was valued at $500,000, the value of the asset would be $500,000.
10. What is the legal effect of a disclaimer?
If the disclaimant executes a proper disclaimer, then the disclaimant will be treated as having predeceased the decedent and the disclaimant’s inheritance will vest in another individual except in the case of a spouse. IRC §2518(b)(4)(A); Treas Reg §25.2518-2(e)(2).
11. Can a disclaimer be used by a disclaimant to avoid creditor claims?
Yes, a disclaimer is binding on creditors and does not constitute a fraudulent conveyance. Prob C §§281, 283. However, federal tax liens do attach to the disclaimed property. Drye v U.S. (1999) 528 US 49.
For example, if a hotel heiress incurred substantial debt by means of outlandish purchases, she could actually disclaim her inheritance so that creditors could not attach their claim to her inherited property. Yes, sad but true.
12. Is there a time limit to make a disclaimer?
Yes, the disclaimer must be delivered within 9 months of death (or other date of transfer) to "the transferor of the interest, the transferor's legal representative, the holder of the legal title to the property to which it relates, or the person in possession of such property." Treas Reg §25.2518-2(b).
13. Can I disclaim only a portion of the inheritance?
Yes, a beneficiary can disclaim one interest in property and retain another. IRC §2518(c); Treas Reg §25.2518-3. For example, if a beneficiary was left with 100 shares of Exxon Mobil, the person could disclaim 50 shares and keep 50 shares because stock is considered severable property. Treas Reg §25.2518-3(a)(1)(ii).
The estate tax might be the most discussed issue in estate planning but most certainly not the most relevant given the circumstances of most individuals. For example, almost invariably the first question I am asked by clients at our initial meeting is whether the government will inherit their entire estate or impose substantial taxes on it. Almost always, my response is “no.”
Regardless, the following are some common questions that deal with the nuances of the estate tax.
1. What is the federal estate tax?
The federal estate tax is a tax levied against a decedent's taxable estate by the IRS when the estate is in excess of a fixed amount. This fixed amount is known as the applicable exclusion or exemption amount.
2. How is taxable estate calculated?
The taxable estate is determined by subtracting certain deductions from the decedent's gross estate. IRC §2051.
The gross estate includes all of the decedent's property, real or personal, tangible or intangible, wherever located IRC §2031(a). For example, this figure includes homes in the U.S. and abroad, bank accounts, stocks, retirement accounts, mutual funds, bonds, promissory notes, copyrights, patents, yachts, jewelry, castles, planes, trains and automobiles, etc.
The deductions include items such as expenses, indebtedness and taxes. IRC §2053. The most common deduction is for the mortgage amount remaining on the decedent's home. Treas Reg §20.2053-7.
For illustrative purposes, if the decedent owned a $10,000,000 home with a mortgage balance of $3,000,000 along with a bank account worth $500,000, stocks worth $500,000, bonds worth $2,000,000 and mutual funds worth $1,000,000, then their taxable estate would equal $11,000,000.
3. Who is affected by the estate tax?
The estate tax is imposed on every decedent who is a citizen or resident of the United States. IRC §2001(a).
Nonresident aliens are taxed on U.S.-based property. IRC §§2101, 2103.
4. What is the exemption amount in 2011?
The exemption amount in 2011 is $5,000,000.
5. What does $5,000,000 signify?
The $5,000,000 figure signifies the maximum amount at which taxes will not be owed. For example, if a person passes away and leaves a $3,000,000 estate, then no estate tax will be due.
Conversely, if a person passes away and leaves a $6,000,000 estate, then the estate tax will be levied on $1,000,000.
6. Does California have a state estate tax?
For decedents who passed away after December 31, 2004, there is no California estate tax. However, for decedents who passed away earlier, there may be an estate tax due.
7. What is the maximum estate tax rate in 2011?
The maximum estate tax rate in 2011 will be 35%. This means that no matter how large the estate, for example $10 billion, the maximum taxation rate for such an estate will not exceed 35%.
8. How do people plan for the estate tax?
There are numerous planning strategies that address the challenges posed by the estate tax. The most common method to cope with the estate tax is to write an AB trust. In short, an AB trust will allow a husband and wife, who are both U.S. citizens, the opportunity to leave to their beneficiaries, tax-free, double the estate tax exclusion amount. The link will provide more detail about this.
9. Is the estate tax relevant given the high exemption amount?
The answer depends on who is answering the question. For the wealthy individual, the estate tax is a huge estate planning issue since taxation can consume a significant portion of their estate. However, since very few people have over $5,000,000 in assets, there is no need to be concerned with a largely irrelevant issue. Out of the millions of people who will pass away next year, maybe a few thousand or less will be affected by the estate tax.
10. Will the estate tax ever be an issue for me?
Since the estate tax is a controversial and fluid issue, the estate tax will continue to be relevant. For example, the chart below shows the estate tax exemption amount and rates for each year since 2001. The chart shows that the estate tax has been subject to fluctuations over the past decade.
Year Amount Excluded Maximum Tax Rate
2001 $675,000 55%
2002 $1 million 50%
2003 $1 million 49%
2004 $1.5 million 48%
2005 $1.5 million 47%
2006 $2 million 46%
2007 $2 million 45%
2008 $2 million 45%
2009 $3.5 million 45%
2010 Repealed 0% (restrictions apply)
2011 $5 million 35%
11. Does a high estate tax exclusion amount render estate planning irrelevant?
Regardless of the consequences of a high estate tax exclusion amount, there are many issues in estate planning that affect a large portion of the population. For example if a person's estate is, generally speaking, in excess of $100,000, then upon that person's passing, a probate will be needed to distribute the estate to the beneficiaries. Since probate is quite expensive and lengthy, the avoidance of it is recommended by estate planning attorneys. Thus, people write trusts to avoid probate.
12. Are there tax laws related to the estate tax?
Yes, there are many tax laws related to the estate tax. One important related law is the gift tax. The gift tax was enacted to prevent people from giving away, or gifting, all of their estate in order to avoid paying the estate tax. Thus, the gift tax caps the amount a person may gift to another person. The recently amended estate tax law, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, increased the amount of the lifetime gift tax exemption from $1,000,000 to $5,000,000.
13. Why is the estate tax such a controversial issue?
The estate tax is a controversial issue because political ideologies clash markedly. There are plenty of other arguments for and against the estate tax but here is one from each side. Progressives see the estate tax as preventing dynastic transfers of wealth that create trust fund babies who lack the necessary ambition in life to succeed. Conversely, conservatives see the estate tax, or Death Tax as they like to call it, as an unfair form of taxation because the estate has already been levied an income tax.
14. Who benefits from the estate tax?
Clearly the federal government benefits because the estate tax generates billions of dollars of revenue for it. Also, estate planning attorneys, financial advisors, certified public accountants and associated professionals benefit from the estate tax because the very wealthy enlist their help to cope with the estate tax.
15. When was estate tax instituted?
The estate tax was first enacted in 1916. Since then, it has been amended numerous times.
16. Can the estate tax be repealed?
Yes, like any law, the estate tax can be repealed.
17. What happened in 2010?
Due to partisan squabbling, Democrats and Republicans were unable to amend the estate tax for 2010, which caused a temporary repeal. I do not know of any estate planning attorney who thought this would happen. This meant that regardless of the size of the decedent’s estate, no estate tax would be due in 2010.
However, other portions of the estate tax law changed in 2010 as well, most notably the “stepped-up basis” rules. In understandable language, “stepped up basis” means that a beneficiary inherits the basis of the property at the date of death value from the decedent. IRC §1014. For example, if the decedent purchased a home for $100,000 and when they died was worth $1,000,000, the beneficiary would inherit the property for $1,000,000. Then when the beneficiary later sells that asset for $1,000,000, no taxes would be due because no capital gain would have taken place.
Consequently, the vast fortunes of people such as George Steinbrenner, the former owner of the New York Yankees, and Dan Duncan, a Texas multi-billionaire, were seemingly going to be transferred tax-free to their heirs. However, due to the estate tax law, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the heirs of these fortunes are now confronted with the option of using the estate tax rules of 2010, with its unlimited estate tax cop but limited the stepped up basis rules, or the estate tax law of 2011 with its estate tax cap of $5,000,000 but with an unlimited amount of stepped basis.
If you have a rather large estate, then you might have heard of a legal document known as an A/B trust. Here are some common questions associated with an A/B trust.
1. What is an A/B trust?
An A/B trust is an estate planning device used by couples in which the surviving spouse utilizes the applicable estate tax exemption of the deceased spouse through the medium of a separate trust. It sounds complicated but in application it is straight-forward. If the estate tax is not amended for 2011, then the applicable exclusion amount will be $1 million. Consequently, if your estate then exceeds $1 million, then that portion will be subject to the estate tax. However, tax law favorably treats transfers among spouses and thereby an A/B trust comes into play. IRC §2056.
In regards to the estate tax, tax law allows the surviving spouse to utilize the deceased spouse' applicable exclusion amount when they pass away.
For instance, Hal and Wendy were a married couple whose estate was worth $2 million. They also had two kids named Samuel and Donna. Hal unfortunately passed away in June 2011 in an auto accident (call me clairvoyant). Wendy is potentially faced with an enormous tax bill in that $1 million will be subject to the estate tax. Yet Hal and Wendy carefully planned for a day like this when they drafted their estate plan years earlier.
Hal and Wendy's joint marital trust allowed for two additional trusts to be created when the first spouse passed away, an A trust, also known as a Survivor's trust and a B trust, also known as a Bypass or Credit Shelter trust. The B trust would be funded with Hal's applicable exclusion amount, namely $1 million. Conversely, the A trust would be funded with the remainder of the estate not allocated to the B trust. In this case, that would be $1 million. Thereby, Wendy would not have to pay the estate tax on Hal's passing even though his estate exceed the exclusion amount, $1 million.
Years later, Wendy passes on and leaves everything to her two children Samuel and Donna. At her death, Wendy's A trust is worth $800,00 and the B trust is worth $900,000. Had a B trust not been created, Samuel and Donna would have to pay the estate tax because Wendy's estate exceeds the applicable exclusion amount, $1 million. In particular, Wendy's estate would be subject to roughly a 43% tax on $700,000, the amount over the $1 million estate tax exemption. However, since Hal and Wendy created an A/B trust, their children are spared from paying the estate tax. The reason for this is because the B trust is not included in Wendy's estate for estate tax purposes.
This example assumes that the estate tax is not amended from the $1 million exemption amount that comes into effect in 2011.
2. Are there any important prerequisites for creating an A/B trust?
Yes, since federal law does not recognize same-sex partnerships, only heterosexual couples may take advantage of an A/B trust.1 USC §7. Furthermore, only U.S. citizens may create an A/B trust. IRC §2056(d)(4).
3. Do I need an A/B trust?
The answer to this question is not a simple yes or no response. An A/B trust only comes into play when married couples have an estate larger than the applicable estate tax exemption amount. For instance, if Hal and Wendy 's estate from example 1 was $200,000, then it would not make sense to create an A/B trust since the estate tax would not be an issue for them. However, it is reasonable to assert that the net worth of couples can change dramatically over time, whether through employment or good fortune. Hence, it would be imprudent to say that an A/B trust is never appropriate. Ultimately, each couple's situation needs to be evaluated on a case by case basis.
4. What are the benefits of an A/B trust?
The main reason why an A/B trust is drafted is to lessen the effects of the estate tax. An A/B trust essentially allows a married couple to leave twice the applicable estate tax exemption amount to their beneficiaries free of tax. For example, if the estate tax exemption is increased to $3.5 million, this basically allows parents to leave to their children $7 million tax free.
5. What are some of the costs of an A/B trust?
Since there are multiple trusts involved, there is a large amount of administrative work involved. This takes the form of filing tax returns, segregating the trusts assets, following the terms of the two trusts, distributing the assets in accordance with the terms of the trust, etc.
