Strategy to Help Bypass Estate Taxes

A Gallup poll found that about 2 percent of Americans believe they are "rich," which was defined as having a $120,000 annual income or $1 million in financial assets.¹ 

Are you "rich" enough that your heirs could be required to pay estate taxes? Fortunately, federal law allows a surviving spouse who is a U.S. citizen to inherit unlimited assets. But what happens after that? Is there a way for a married couple to help shield more than the allowable individual exemption amount from federal estate taxes after the surviving spouse dies?²

Fortunately, by setting up a properly structured living trust with an A-B provision (also called a bypass trust), a married couple can potentially double their use of the applicable exemption.³ 

When the first spouse dies, an amount up to the applicable exemption amount ($1.5 million in 2004 and 2005) is placed in Trust B (the deceased spouse's trust), and the remaining assets are placed in Trust A (the survivor's trust). The surviving spouse retains control of Trust A and can receive income from both trusts. Upon the second spouse's death, the assets in Trust B generally pass to their heirs free of probate and federal estate taxes provided that the trust is irrevocable and the surviving spouse is not considered the owner of the trust. Estate taxes would be due only on assets in Trust A that exceed the applicable exemption amount in the year of the second spouse's death. In 2004, federal estate taxes on a $3 million estate would be $705,000. In this hypothetical example, the estate taxes on two $1.5 million trusts would be zero.

Federal estate taxes are slated to be eliminated in 2010, but it is still unclear whether their demise will be permanent. Planning as though they will remain a potential liability may help protect your heirs regardless of what happens to estate taxes in the future.

1) The Gallup Organization, 2003
2) Under budget rules of the 2001 tax law, the estate tax is repealed in 2010. However, unless Congress takes action, the federal estate tax will be reinstated in 2011.
3) The use of trusts involves a complex web of tax rules and regulations. You should seek the counsel of an experienced estate planning professional before implementing such strategies.

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