Trusts, Estate Planning and Estate Taxes
by Jerri Blaney, P.A.
Many physicians have been structuring their assets so as to protect those assets from an adverse professional liability judgment. This frequently means owning assets as tenants by the entirety. While this may be prudent from a protection standpoint, it is not the most advisable from an estate planning standpoint.
Until recently, the majority of tax planning was based on saving income taxes. The Tax Reform Act of 1986 reduced income taxes to a new low of 28 percent. In contrast, the top estate tax id 55 percent and the unified credit against estate and gift taxes (which shelters $600,000 from estate and gift taxes) is phased out for estates between $10,000,000 and $20,000,000. This means that if you would rather have the net worth you worked so hard to build up to your family or other beneficiaries rather than the IRS, you need to do some planning now.
Through appropriate estate planning it is possible to exempt $1,200,000.00 plus the amount of any insurance from estate tax. Adequate planning can result in estate tax savings of $192,800. It is also possible to prevent the imposition of any estate tax at all from being levied in the death of one spouse with the other spouse surviving.
How is this accomplished? For example, assume our hypothetical family consists of a physician husband, a homemaker wife and two minor children. They have a net worth of $2,000,000. The husband dies first.
First, let's see what happens if he has not done any estate planning and had owned all of the assets in his own name. Under the Florida Statutes, the wife receives the first $20,000 and the remaining $1,980,000 is divided equally between wife and children so that the wife receives $1,010,000 and the children receive $990,000. The wife's share, therefore, would qualify for the unlimited marital deduction so no estate tax would be due. The children's share would be subject to estate tax. If the husband's unified credit is applied to the children's share then approximately $390,000 would be subject to tax. The tax then is estimated to be approximately $160,000. The estate tax is due in full in cash nine months from the date of the husband's death. When the wife later dies, the children will receive her $1,010,000. After allocation of her unified credit, a tax of approximately $200,000 would be due.
Therefore, the children will control their inheritance as soon as they reach the age of 19. In addition, it means that the estate tax of $160,000 is paid earlier than would be necessary with appropriate planning. Finally, the wife loses control and use of the children's inheritance upon the husband's death, rather than retaining control to the parents during their lifetime.
Next let's see what happens if the husband and wife owned all of their assets as joint tenants or tenants by the entirety. Under Florida law, the wife as the surviving joint tenant inherits everything. Assets would not pass to the children while either spouse is alive. There would be no estate tax because of the unlimited marital deduction. However, the husband's unified credit against estate tax is wasted because when the wife dies, the entire amount is in her gross estate and subject to estate tax. If, for example, she died the next day, the entire $2,000,000 would be subject to tax. There would be a credit against the tax on the first $600,000, the remaining tax would be approximately $600,000.
Comparing this situation to the previous situation, we find that the amount of overall estate tax is greater where the husband and wife own everything as tenants by the entirety. However, payment of part of the estate tax is due earlier in the first situation where the children inherit upon the death of the husband.
Now, let's see what can be done through estate planning. Through the use of trusts, upon the death of the husband two trusts would be established: a marital deduction trust and a unified credit trust. The unified credit trust would contain the amount of assets sheltered by the husband's unified credit against estate and gift taxes ($600,000). There would not be any estate tax because of the unified credit. The marital deduction trust would contain the remainder of the husband's estate. There would not be any estate taxes due on the husband's death. Estate planning does not benefit the wife but benefits the children who pay the estate tax when they receive the assets upon the death of the wife, because of the unlimited marital deduction.
Assume the wife dies the next day. Only the assets in the marital deduction trust would be in her gross estate (not the $600,000 in the unified credit trust). The wife's unified credit could be applied so that the wife's estate would pay an estate tax only on $800,000. Thus, the amount of the tax would be approximately $360,000.
What should the terms of the trusts be? In general, the terms can be as restrictive or as broad as you want them to be. The only restriction is that the marital deduction trust must pay the income at least annually to the surviving spouse who in the above example is the wife.
The marital deduction trust could be set up so that the wife is the sole trustee and decides the investment and management of the trust. The wife would be paid all of the income quarterly. The wife would have the right to withdraw principal if she needed it for her living expenses (for her health, care, support and maintenance) in accord with her standard of living at the time her husband died and taking inflation into account. The wife would also have the right to withdraw five percent of the trust principal each year if she wanted to. All of these powers taken together give the wife almost as much control as if she owned the property outright.
The unified credit trust would have the same provisions as the marital deduction trust and in addition, would provide that the wife could distribute principal to any of the children or grandchildren for any reason.
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Thus, both trusts have a great amount of flexibility. The wife invests the trust assets in any fashion that she chooses. The wife receives the income currently. The wife has the use of the principal if she needs it to maintain her current standard of living. In the unified credit trust, the wife can distribute any or all of the principal to the children and grandchildren.
This program uses the husband's and the wife's unified credit fully. Hence, the program allows $1,200,000 to pass to the children estate tax free through the death of both husband and wife.
In addition to the estate tax savings, the program protects the assets for the family. A future spouse of the wife can not reach the assets. Creditors generally cannot attach the assets.
It is possible to set up a sensible distribution scheme under such a trust. Rather than distributing the assets outright to the children upon the death of both parents, the trust can give the children the opportunity to get accustomed to their inheritance first. For example, the trust could provide for payments of one-third at the age of 30, one-third at the age of 35, and the remainder at the age of 40.
It is possible only through appropriate estate planning to achieve the usual family objectives: 1) allow the parents to retain full control during their lifetimes. 2) allow parents complete use of the funds during their lifetimes, 3) fully use both spouses unified credit against estate and gift tax to permit $1,200,000 to pass without imposition of an estate tax saving some $385,600 in estate taxes, 4) distribute their inheritance to the children over a period of time at ages when the parents decide they can handle their inheritance.
To further minimize the ultimate estate tax, any life insurance (especially term life insurance) should be transferred to an irrevocable trust under which the death payment of the insurance would not be included in the insured husband's estate. Special issues such as second marriages, charitable deductions, the excise tax on pension plans, the generation skipping tax and homestead should be addressed on an individual basis.
Comparison - Illustration 4
Jerri M. Blaney is a tax and estate attorney in private practice in Palm Beach County.