Funding "exemption-saving" trust from spousal disclaimer?

Right. That's called a marital trust under IRC §2056.

There are a couple of problems. First, a disclaimer is a specific legal procedure where you decline a gift within a limited period of time, and it passes as if you had died before the person who gave you the gift. So a disclaimer could not pass property to a marital trust.

On the other hand a gift that allowed the surviving spouse to take what she wanted and put the rest in the marital trust would be considered a gift to the spouse, and could not thereafter qualify for treatment as a marital bypass trust.

Well, better drafted trusts don't use a specific dollar amount - they refer to the estate tax lifetime exemption amount on the date of death of the first spouse to die.

In your specific example, a better drafted trust would only bring into the marital trust those funds that exceed the exemption amount

- $1,000,000 in the example, so that it would be funded with only $100,000.

There is one set of rules that is used to give the spouse more or less flexibility depending on the wishes of the spouses. The surviving spouse can be the trustee of the marital trust, thus having pretty much whatever control is desired. The restriction is that the surviving spouse can only dip into principal of the bypass trust to the extend she needs it for her health, support or maintenance.

That restriction actually helps reduce taxes, since the bypass trust has already been taxed and won't be taxed again when the surviving spouse dies, while the surviving spouse's trust will be taxed when she dies. So if she lets her trust grow while reducing the bypass trust, she could be looking at paying more taxes than necessary.

If the surviving spouse does not want to have that limit imposed on her access to the bypass trust, the law allows that if decisions to dip into principal are made by an independent trustee.

So how about having the wording in the will then be something like "all my assets to my wife, but if she predeceases me then to Foobar Family Trust"? Then the disclaimed assets would follow the "but..." clause?

Even if the will (which is what is putting the assets into the trust) referred to the lifetime exemption in effect on date of death of the testator, the overall potential problem would remain.

That would seem to be the exact opposite of what one would want. The purpose of these trusts as I understand it is generally to fund it WITH the exemption amount so that the benefit of the entire exemption amount is experienced with the rest of the assets being shielded by the unlimited marital exemption.

Let's take your example with someone dying worth $3mil when the current exemption is $1mil. Your approach would put $2mil into the trust and leave $1mil to the spouse. In addition to "shortchanging" the spouse, that would leave $1mil of assets subject to the estate tax since the exemption would only cover $1mil of the $2mil of assets put into the trust.

Ok. Maybe that's our disconnect. You appear to be talking about a two-trust approach (marital trust and bypass/remainder trust).

I'm only talking about the bypass trust part of this. I'll be honest that it's not clear to me what the purpose of the marital trust is for, at least for someone who in the absence of estate taxes would just bequeath all their property outright to their spouse (since from what I read about "marital trust", it basically has to give the surviving spouse general power of appointment over the property in order to qualify for the unlimited marital deduction -- which means the spouse could take any/all of the assets from the marital trust whenever she wants to).

And even in a marital+bypass scheme the same problem I'm referring to exists. Say the exemption is $1mil and the estate is $1.1mil at death. $100,000 will go to the marital trust and $1,000,000 will go to the bypass trust. So most of the assets are restricted from the surviving spouse. Which may well not be what anyone wanted.

Hence the desire to let the surviving spouse make the decision as to how much goes into the bypass trust and how much goes into the marital trust (or just outright to her). She might want to have more unrestricted assets at the cost of wasting some of decedent's exemption. Might be wise, might not be wise, but be that as it may, being able to let her make the decision is what I'm driving at.

-- Rich Carreiro snipped-for-privacy@rlcarr.com

Generally you would not want to deplete the bypass trust amount to less than the currrent estate tax exemption. But consider that the estate was already divided roughly in half, or in a community property state it is one half, then the widow gets half the estate anyway because it's hers, not in his estate, plus the $100,000 in the above example, plus the income from the entire $2,200,000 plus the right to invade the bypass capital for necessities. If she uses up all that her children won't get anything (and there then wouldn't be any estatae tax anyway. ). .

ed

Can you use a formula? This gives you maximum flexibility.

amount to put into the trust is:

min(estate exemption at time of death, deceased person's estate minus

500000)

If deceased person's estate drops to 1.1 million, only min(1000000,

600000)`0,000 goes into trust. 500,000 goes directly to surviving spouse.

Yes, you can use a formula.

The fundamental assumption here appears to be that it is inherently "better" for the surviving spouse to inherit outright rather than in trust. Based on

40+ years of doing estate planning, I question that assumption.

First of all, trusts offer protection from ex-spouses (if the surviving spouse remarries), creditors and bankruptcy that is lost when property is inherited outright.

Secondly, if the marital trust is structured as a QTIP, the only power you don't want to give the surviving spouse is a general power of appointment; e.g., a power to appoint to her creditors or her estate. The surviving spouse must receive all of the income, may have rights to invade principal under an ascertainable standard and a power to dispose of the marital trust at her death in favor of anyone in the world other than her estate or her creditors. When you add to that the fact that the surviving spouse may serve as sole trustee without adverse tax consequences. he/she has powers tantamount to outright ownership.

Thirdly, the surviving spouse may be given the same powers over the Credit Trust.

Since the surviving spouse has the power by his/her Will to change the remainder beneficiaries, he/she essentially has the power to eliminate beneficiaries, which keeps the remainder beneficiaries (typically the children) in line.

In my years in practice, neither I nor any of my partners in our trusts and estates department have had a surviving spouse complain that the trust prevented him/her from doing what he/she wanted.

Jon Gallo

What are the trust tax rates? Does the interest, dividends, capital gains flow to the individual? Or are they taxed at the very high trust tax rates -- almost a flat 35%?

The rates rise very quickly. Over $0 - 15% Over $2300 - 25% Over $5350 - 28% Over $8200 - 33% Over $11200 - 35%

Income that flows to the individual flows through a schedule K, and is treated as if earned by the recipient. A trust isn't the best tool for tax avoidance. It's best used (among other things) to preserve the Estate tax exemption and to protect one's heirs from themselves.

With a married couple, the estate plan typically involves a QTIP marital trust (the most typical way of qualifying for the marital deduction) and a credit trust to safeguard the estate tax exemption. In the marital trust, all income must be distributed to the surviving spouse at least annually. In that case, the trust has an distributions deduction which zeros out taxable income and the surviving spouse reports the income. The credit trust is either exclusively for the surviving spouse (in which case it probably zeros out the taxable income through distribution of all income to the survivor) or a pot trust for the survivor and issue. In a pot trust, income can either be accumulated or distributed. While the maximum income tax rate for trusts is reached at slightly more than $11,000, accumulated income may be reinvested and pass free of estate tax at the surviving spouse's death. In that case, it is a business judgment question of balancing the combined state (if any) and federal income tax cost of accumulating income against the savings in avoiding the combined state (if any) and federal estate and inheritance taxes not only on the after tax income but also the subsequent appreciation of assets acquired with that income, all of which will escape estate tax at the survivor's death.

As to using trusts to "protect one's heirs from themselves" this assumes that the heirs are not financially responsible and that the trust will have a third party trustee. This certainly occurs from time to time. I've spent over 40 years with a large law firm that services an affluent client base on the West Coast and the need to protect the heirs from themselves tends to occur about 25% of the time. The majority of my clients use trusts rather than outright bequests in order to take advantage of the protections from divorce and creditors afforded by trusts. In these situations, the beneficiary serves as trustee of his/her trust and receives all of the net income, with the result that the trust is only a separate taxpayer for capital gains purposes.

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(snip)

My poor wording. I meant things other than taxes. I was adressing the trust tax rates, and should have said "themselves or others, both creditors and ex-spouses/new spouses." Good clarification, Jon, thx.