Splitting wealth has tax advantages

Pursuant to our discussion in the last article, I said we would be considering the use of the By-Pass trust will or living trust in order to achieve the maximum that a couple can pass to their family or other loved ones tax free.

The predicate to understanding this strategy, dictates that we go back to Section 2056(a) of the Internal Revenue Code. It allows a married person to leave an unlimited amount of wealth to his or her spouse at death and during life in “inter vivos” gifts.

A husband can give a wife $20 billion for her birthday — or on July 4 — or any other time (including his death) and experience absolutely no taxable consequences. This is what is called the unlimited marital deduction. It is an amount that is deducted from the “gross estate” on the Estate Tax Return to arrive at the taxable estate.

The U.S. Congress, however, placed a limitation on what an individual can leave to his or her other heirs or friends during a lifetime or at death without imposing a taxable consequence.

Under current law, it is $2 million for 2007 and 2008. This is the “unified credit”. In 2009, it goes to $3.5 million and in 2010 the estate tax is completely eliminated. Unless Congress acts otherwise, it will revert to $1 million in 2011 and for years thereafter.

It is the norm for my practice to utilize a living trust to establish the “estate plan.” What happens is rather simple. First, for each spouse, we establish and fund a trust with two shares or portions. The first portion is the maximum amount that can pass tax-free to the heirs (currently $2 million) and call that share the Family Trust.

Secondly, we establish the Spousal Trust and call that the Spousal Share. Remember, this can be a trillion dollars and not trigger any estate tax at the death of the first spouse. Realistically, however, the surviving spouse can act as the trustee and lifetime beneficiary of the Family Trust if he or she needs the income from that trust for living expenses.

However, our goal is to leave this trust alone and let it grow estate-tax-free for the kids. But, it is there as a secondary source of income if the spousal trust is insufficient to meet the living needs of the surviving spouse along with his or her own assets and income.

So, we see that the intended goal is to leave the maximum amount in the Family Trust share ($2 million) and to give everything over and above that to the surviving Spouse in the Spousal Trust share.

When Spouse No. 2 dies, hopefully, we will have at least $2 million remaining in the Family Trust and also a large portion of wealth remaining in the Spousal share as well. Also, know that the surviving spouse should have owned exactly 50 percent of the family wealth in his or her own trust.

Now when the second to die passes away, we should have $2 million going tax-free from the Family Trust directly to the kids from the first to die and $2 million from the estate or trust of the second to die of the couple. This makes $4 million in 2007 and 2008 that we can pass tax free.

Only the excess over $2 million in the estate of the second spouse to die would be taxable by the IRS. This excess would include all of the amount in the Spousal trust from the first to die which was included in the estate of the second to die!

It is only the amount over the $4 million figure that would be taxable. Be aware that the Family Trust of the first to die spouse never “legally” enters the estate of the surviving spouse. It is a “beneficial” interest — not a “legal” interest. Thus, it does not actually qualify as the property of the second to die spouse if the estate planning professional does a good job in the trusts or wills.

For many of the farmers and small business owners reading this article, you should be saying that much of your wealth is tied up in the farm or small business and not in cash. And right you are! That is why you do not want to use just any attorney. You need a lawyer who specializes in estate planning. This is not something you want a general practitioner to do for you.

You want the lawyer to guide you through the necessities of splitting all your wealth into two piles to be placed into a trust for each spouse or if you don't use a living trust, to be owned individually and separately from each other. Remember, joint tenancy is a dirty word in tax planning in this arena. We don't want to automatically take ownership by rights of survivorship of the decedent spouses' share of the assets. We want to legally split it up to take advantage of the Family trust allowance/unified credit.

Well, I am out of time and space. In the next article, we will continue on this intricate path. Please feel free to call, email or write me with any of your questions or comments. God bless you all and have a Merry Christmas season.

Mark Tippins is an Auburn, Ala., attorney licensed in Alabama and Florida. For questions or comments, he can be contacted at [email protected] or (334) 821-3670.

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