|
Applicable Exclusion Amount
Just as every person's estate is
subject to the Federal estate tax, each person also
receives a fixed dollar amount that can be applied to
the amount of estate tax that is actually owed.
This credit is known as the "unified credit" or the
"applicable exclusion amount" and operates to reduce the
amount of federal estate tax that must be paid.
As a credit, the applicable exclusion
amount can only be used when the estate actually owes
tax. An estate that doesn't owe any taxes or owes
less than the available unified credit simply doesn't
pay any Federal estate tax. The estate does not
receive a payment from the I.R.S for the amount of
available, but unused credit. The applicable
exclusion amount is also personal, meaning that it
cannot be shared or transferred between people or
estates. This inability to transfer the credit
means that any amount which is not used at the time of
death simply expires.
Taxable Estate
The taxable estate is the dollar
amount that represents the total of the fair market
value of everything a person owns at the time of death,
less the allowable deductions. Allowable
deductions include items such as debts, funeral costs,
transfers to qualified charitable organizations, and
administration expenses. The value of all property
that is transferred to a surviving spouse with United
States citizenship is also an allowable deduction, which
is often called the "unlimited marital deduction."
All allowable deductions are
subtracted from the deceased's gross estate to determine
the taxable estate. Once the taxable estate is
known, the applicable exclusion amount is applied to
determine whether any amount of tax must be paid.
Unlimited Marital Deduction and
the Taxable Estate
Although the unlimited marital
deduction allows a surviving spouse to receive the
deceased spouse's entire estate without incurring any
Federal estate tax, it also prevents any use of the
deceased spouse's applicable exclusion amount.
When all of the deceased
spouse's property is transferred to the surviving spouse
the deceased spouse is left without a taxable estate.
Although there won't be any tax due, the deceased
spouse's applicable exclusion amount remains unused and
will simply expire.
For those who have combined
estates significant enough to incur Federal estate tax,
this loss of the applicable exclusion amount will most
often affect their children. Failure to use the
unified credit is not a concern when the property is
transferred from the first deceased spouse to the
surviving spouse. The concern with failing to use
the first deceased spouse's unified credit comes when
the second spouse dies and passes the combined estates
of both spouses.
Example Scenario
In 2006 Howard and Marion have
individual estates valued at $2,000,000 and two
children, Richie and Joanie. These basic facts
will be used in both of the following examples, which
are designed to show the interaction of the unlimited
marital deduction with the applicable exclusion amount
and the use of trusts to maximize the tax benefit
available when a married couple's combined estate is
passed on to the next generation.
Note that these examples would
apply without any regard to which of the two spouses
dies before the other.
Without a Credit Shelter Trust
Howard dies in 2007 and, as is
typical, uses his will to leave all of his individually
owned property to his spouse Marion. The entire
$2,000,000 passes to Marion and is combined with her
existing $2,000,000 to give her a total estate of
$4,000,000. Using the unlimited marital deduction,
Howard's $2,000,000 is subtracted from his gross estate
to give him a taxable estate of zero. Without a
taxable estate, Howard's estate does not owe any Federal
estate tax. However, without owing any tax,
Howard's $2,000,000 applicable exclusion amount cannot
be applied and remains unused.
When Marion dies in 2008 her
will divides the full amount of her $4,000,000 estate
equally between Howard and Marion's children. The
$2,000,000 applicable exclusion amount available in 2008
can be subtracted from her $4,000,000 taxable estate to
leave a balance of $2,000,000 for which the Federal
estate tax must be calculated. As shown, the final
result is $1,550,000 being given to each child.
|
Credit Shelter Trusts
In order to make use of the
deceased spouse's applicable exclusion amount, the
deceased spouse must have a taxable estate.
However, as all estate property given directly to the
surviving spouse is excluded from the taxable estate, it
would seem that the only way to create a taxable estate
is to give a portion of the estate to someone other than
the surviving spouse.
For most people, the surviving
spouse is the main concern and, although they may also
be interested in reducing taxes, they would rather
provide for their spouse. Credit shelter trusts
provide a means to satisfy both of these goals.
A credit shelter trust creates
two interests. One interest belongs to the
surviving spouse throughout the duration of his or her
life. The other interest typically belongs to the
children, who are entitled to receive all property that
remains in the trust following the death of the second
spouse. For purposes of the Federal estate tax,
the most important feature of this trust is its
requirement that the someone other the surviving spouse
take its property when the surviving spouse later dies.
In order to achieve the desired effect, the surviving
spouse cannot have any influence or control over who
receives the trust property after his or her death.
Basically, by giving the
property to someone other than the surviving spouse, the
property does not qualify for the unlimited marital
deduction and is taxable. Although the trust
property is not given directly to the surviving spouse,
the surviving spouse is permitted to make use of the
trust property for specific purposes throughout the
remainder of his or her life. One of the key
aspects of the trust is the strict limitation of the
surviving spouse's use to ascertainable standards with
clear limitations. The currently acceptable
language limits use of the property for the surviving
spouse's "health, maintenance, welfare, or education."
It is also possible to permit annual withdrawals of
principal or income based upon amounts with strict
limitations.
By also dictating who receives
the property and by preventing the surviving spouse from
exerting any control over who receives it, the remaining
trust property is also not included in the surviving
spouse's estate at the time of his or her later death.
Use of a Credit Shelter Trust
Howard dies in 2007.
Rather than use his will to leave all of his
individually owned property to his spouse Marion, his
will passes the entire $2,000,000 to a credit shelter
trust. The trust names Marion as the sole
beneficiary during her life, with Richie and Joanie as
the beneficiaries of everything that remains in the
trust at Marion's death.
Naming his children as the
remainder beneficiaries of this trust is sufficient to
create a taxable estate of $2,000,000 which is equal to
the applicable exclusion amount during that year.
As his taxable estate does not exceed the applicable
exclusion amount, Howard's estate does not pay any
Federal estate tax.
When Marion dies in 2008 her
will divides the full amount of her $2,000,000 estate
equally between Howard and Marion's children. With a
taxable estate equal to the applicable exclusion amount
of $2,000,000 Marion's estate does not pay and Federal
estate tax.
Marion's death also triggers the
end of the credit shelter trust that was created at the
time of Howard's death. The full amount remaining in
the trust is given directly to the remainder
beneficiaries, Richie and Joanie.
The property held in the credit
shelter trust is not includible in Marion's taxable
estate at the time of her death, because it was not
directly owned by her and is not includible in her
gross estate. Although she could use and benefit
from the property, she could not freely withdraw it
without limitation and could not direct who would own it
Although the trust property did
not incur any payable tax at the time of Howard's death,
the trust property was already subject to taxation at
that time and will not be subjected to the tax when it
is formally given to Richie and Joanie.
Using the credit shelter trust
in this instance allowed the married couple to pass a
total of $900,000 more on to their children.
|
