Estate Planning Primer - 2009
by Thomas C. Rink

The purpose of this Primer is to use the attached flow charts to demonstrate three tools used in estate planning: the unified credit, the unlimited marital deduction, and the equalization of assets between spouses.

The unified credit can generally be described as the right of an individual to pass assets valued at up to $3.5 million in 2009 free of federal estate taxes at death. It is available in the form of a credit against the amount of the estate tax that would otherwise be due.

The unlimited marital deduction is the right of every spouse to make transfers, during life or at death, to the transferor's spouse free of federal transfer taxes. Transfers to spouses are deducted in calculating what would otherwise be taxable transfers.

In each of the attached examples, we assume that husband and wife own $7.0 million of assets, and that they desire to minimize estate taxes and maximize the amount of assets which can pass to their children.

Chart 1 assumes that the husband owns all assets of the family, and that they have a value of $7.0 million. If the husband dies and leaves everything to his wife, the unlimited marital deduction will reduce the amount of the taxable estate to $0. The wife now owns $7.0 million, and when she dies holding that amount, her estate will avoid taxes on the first $3.5 million because of the unified credit, but the second $3.5 million will result in the wife's estate being charged $1,575,000 in federal estate taxes and the children receiving only $5,425,000. In Chart 1, the husband used the unlimited marital deduction to reduce his taxable estate to $0, thus he did not need to use his unified credit, and it was wasted.

Chart 2 is an example of how the use of a standard Fund A/Fund B trust can reduce estate taxes on the death of the second spouse to die. Again, it assumes that the husband owns $7.0 million in assets. He dies and leaves all of his assets to his trust. (To avoid probate, the husband could place all of his assets in his trust during his lifetime.) The trust agreement provides that $3.5 million is transferred into Fund B (the "credit shelter trust"). Fund B is available for the wife's use during her lifetime, the wife can even be the trustee, but she does not have enough control over Fund B to cause it to be included in her taxable estate when she dies. The remainder of the assets are transferred to Fund A (the "marital deduction trust") which qualifies for the marital deduction, because it will be included in the wife's estate for federal estate tax purposes when she dies. At the wife's death, she will be considered to own the $3.5 million in Fund A. That $3.5 million will be sheltered by her unified credit, which will reduce the amount of taxes she owes to $0. Fund B will transfer to the children free of tax, because of the husband's unified credit, and Fund A will transfer free of tax to the children because of the wife's unified credit. Thus, the A/B trust plan has reduced the tax payable over the deaths of the husband and wife to $0.

Chart 3 is an example of what can go wrong, if the husband continues to own $7.0 million in assets, establishes an A/B trust, but the wife dies first. In this situation, the husband is unable to take advantage of Fund A, because there is no surviving spouse and no marital deduction. The wife dies without being able to use her unified credit to shelter $3.5 million, because she had no taxable assets in her estate. The husband dies holding $7.0 million on which $1,575,000 in taxes must be paid.

Although it is usually expected that the husband will die first, there is no guarantee that such will occur, and Chart 4 is an example of the benefit of transferring assets between spouses to insure that each spouse has at least $3.5 million in order to utilize the unified credit of each spouse. In this situation, the husband has transferred $3.5 million of his $7.0 million to his wife. This transfer is tax-free by reason of the marital deduction. Now, if the husband dies and leaves his assets to his trust, he will have zero taxes, because his unified credit will shelter $3.5 million, and the assets will be held in his Fund B for the benefit of his wife and ultimate transfer to his children. On the other hand, if the wife dies first, her assets will go to her Fund B which will be used for the benefit of her husband, she will owe no tax because of her unified credit, and at the husband's death, once again, the children will receive $3.5 million from each of the husband and the wife tax-free.

As is evident from the foregoing, the basic estate plan for a family with assets in excess of $3.5 million should strive to take advantage of the unified credit of both spouses by splitting assets and providing for the use of a Fund B trust. When assets exceed $7.0 million, tax on the first spouse to die will be avoided by use of the Fund A trust which qualifies for an unlimited marital deduction and insures that taxes will not be due until the death of the second spouse to die. The only tax due will apply to assets in excess of a value of $7.0 million.

There are other tools available to the estate planner to reduce the taxes payable on the transfer of assets in excess of $7.0 million.

As required by IRS Circular 230, this is to disclose that any advice contained herein concerning the tax treatment of an item of income, gain, loss, deduction, or credit, the existence of a taxable transfer of property or the value of property for federal tax purposes, is not intended or written to be used, and cannot be used by any person, for the purpose of avoiding any federal tax penalties that may be imposed on such person.

Tom Rink is a member of the Strauss & Troy Estate Planning Group. To discuss how these issues may affect your specific situation, please contact Tom or any member of the Estate Planning Group.