“How the New $3.5 Million Exemption Amount Affects Your Estate Planning” (Part 3)
Published in the Hokubei Mainichi, Oct. 31, 2009
Now that the estate tax exemption amount has risen to $3.5 million per person, most U.S. households don’t have to worry about estate tax any more. The major reason for new middle-income estate planning is to avoid probate, not to avoid estate tax.
However, people who already have trusts may need to unbuild the too-small, too-complex legal boxes that trust lawyers designed to protect assets from estate tax during past years of more restrictive tax laws.
In my experience, most widows and widowers would rather have the simplicity of keeping a single family trust in their control. Most would rather not have a bypass trust formed unless it is needed to save taxes. If a bypass trust is formed, a separate tax return has to be filed.
Assets such as investment and bank accounts and real estate titles have to be retitled in the names of the different trusts, and thereafter have to be kept separate. The principal that flows into the bypass trust on the first death is not directly available to the surviving spouse, but must be primarily set aside for heirs. Most widows and widowers would rather control their own assets than become merely the caretaker for a part of the assets on their beneficiaries' behalf.
It may be better to restate the trust as a more flexible “disclaimer” trust. This allows the surviving spouse to make decisions about asset control based on the tax laws existing when the first spouse passes away. The survivor can choose how much of the assets to retain under his or her full control in a “survivor's trust.”
After the first death, the survivor can still choose to “disclaim” some assets into an equivalent of the old “bypass” trust, but the survivor can decide how much, and can choose whether to “disclaim” anything at all based on the financial and tax situation after the first death.
Example: $2.5 Million Estate
Suppose a couple with a disclaimer trust had $2.5 million in community property assets, and one spouse passed away in 2008, when the federal estate tax amount was $2 million. The surviving spouse could then have used the flexibility of the disclaimer trust to “disclaim” exactly $500,000, causing this amount to flow into a new irrevocable disclaimer trust.
The disclaimer trust would still have avoided estate tax by the old mechanism of walling off some assets from the surviving spouse’s control, but the surviving spouse would have chosen how much to wall off – in this case, only $500,000 and not half the estate, as a typical older bypass trust provision might have required.
For the same couple, if the first spouse’s death had occurred in 2009 instead of 2008, the surviving spouse could have chosen not to disclaim any assets, since the estate tax exemption amount rose to $3.5 million in 2009 and therefore did not affect a $2.5 million estate at all.
The surviving spouse would therefore keep full control over the entire estate through a revocable trust that could be changed at any time. There would be no need to manage an extra trust and no awkward irrevocable provisions.
Example: $1 Million Estate
If a couple with a $1 million estate had a disclaimer trust, the main purpose of a trust for them would be to avoid a probate court proceeding after the death of the second spouse.
California law still requires a court probate proceeding if a deceased person directly owned more than $100,000 worth of assets that are not passed to someone else through mechanisms such as joint tenancy of a bank account. The amount is even lower for real property (land).
There would be little likelihood of estate tax for this couple unless they suddenly inherited or discovered wealth, or won the lottery. The disclaimer provision would be available to them in case of such good fortune, but it would probably remain dormant, unlikely to be used – much safer than the provisions of a bypass trust, which could force the surviving spouse to split even a small estate and to give up control over part of it.
As the estate tax laws become less restrictive, estate planning lawyers find ourselves undoing our own and our predecessors’ work. At this point it’s a necessary job to protect our clients from their own past exercises of prudence.
If you would like to receive e-mails about the status of the exemption amount and other estate planning issues, feel free to call our office at (415) 584-4550 or (800) 417-5250, and ask to be added to our e-mail list. Upon request, we would also be glad to send you the first two parts of this series
The Law Offices of Laurie Shigekuni
San Francisco Office
2555 Ocean Avenue
San Francisco, CA 94132