ESTATE PLANNING: Estate Taxes II: Maximizing Estate Tax Savings for a Married Couple with Credit Shelter Trusts

The unlimited marital deduction allows a spouse to transfer an unlimited amount of money or other property to the other spouse (who is a U.S. citizen) during life or upon death free of any gift or estate tax. In the case of estate tax planning, so long as the property passing to the spouse is in a qualifying form, the estate will owe no estate taxes if the entire estate passes to the surviving spouse.

The marital deduction is only a tax-deferral strategy, not a tax-avoidance strategy. Too many married couples fail to plan beyond the death of the first spouse, satisfied that no estate tax will be levied when the entire estate of the first spouse to die passes outright to the surviving spouse. This ignores the fact that the combined wealth of both spouses - now held by the surviving spouse alone - will be exposed to estate tax upon the death of the surviving spouse. Depending on the size of the surviving spouse's estate, significant estate tax savings could have been achieved if at least some of the couple's wealth had not passed directly to the surviving spouse.

The key first step in estate tax planning for a married couple is to take full advantage of each spouse's credit from estate taxes, most easily defined by reference to the applicable exclusion amount. For deaths occurring in 2005, a decedent's estate will not be exposed to the federal estate tax if the decedent's gross estate is less than $1.5 million. There is no exposure to the Maine estate tax if the decedent's gross estate is less than $950,000. These exemption amounts can pass to the next generation free of the federal estate tax and the Maine estate tax, respectively.

Assume that George and Martha each own assets worth $1.5 million. They have simple, reciprocal estate plans by which each leaves everything to the other. Assume that George dies early in 2005. George's estate is protected from both the federal estate tax and the Maine estate tax because of the unlimited marital deduction.

Assume further that Martha dies later in 2005 and the value of the assets has not changed. The federal estate tax and the Maine estate tax will be levied on the $1.5 million in assets that Martha inherited from George plus Martha's own $1.5 million.  Martha's gross estate of $3 million will be reduced by $841,500 with $659,500 to be paid for the federal estate tax and $182,000 for the Maine estate tax.

When Martha died, her estate only had the benefit of Martha's credit that exempted $1.5 million of the $3 million estate from federal estate tax. George and Martha could have avoided all federal estate tax and a significant portion of the Maine estate tax if their estate plans had contemplated the federal and Maine estate taxes and incorporated credit shelter trusts, also called by-pass trusts.

The credit shelter trust strategy would have made use of George's credit, as well, by preventing some portion of his assets from passing directly to Martha. In this case, George's $1.5 million would have passed to the credit shelter trust for Martha's benefit. The money passing to the trust would not have the benefit of the unlimited marital deduction (since it is not passing directly to Martha), but that protection would not have been necessary because George's credit for his own $1.5 million federal exemption amount would have shielded the amount passing to the trust from federal estate tax.

Generally, spouses intend to leave all assets to one another for the surviving spouse's benefit. The credit shelter trust generally is set up to provide for the surviving spouse's health, education, maintenance and support, and it can even be written to the benefit of the couple's children, grandchildren and other beneficiaries.

But the spouse does not have the power to appoint the trust property upon her death. If she had that power, then under the Internal Revenue Code, she would have so much authority over the trust property that it would be treated as her own and included in her estate. Instead, upon the death of the surviving spouse, the trust can continue for children or beneficiaries or the remaining undistributed principal and income in the trust can be distributed to individuals, entities or charities, as directed in the estate plan of the first spouse to die.

It is imperative to note that the types of assets the couple owns and the way the assets are owned could defeat this plan. In our example, George and Martha each separately owned assets worth $1.5 million and those assets passed under their Wills. If their estate plans had included credit shelter trusts, the full wealth of $3 million would have been protected from federal estate tax. But if the couple had owned all their assets in joint names, Martha would have become the owner of all the assets upon George's death by operation of the joint tenancy arrangements. The same result would have occurred if George's $1.5 million was owned in assets governed by beneficiary designations, e.g. life insurance policies, annuity contracts and retirement benefits. In both cases, the credit shelter trust strategy would not reach those non-probate assets that would have passed to Martha outside of the reach of George's Will.

When working with your attorney to create a plan to minimize estate taxes, you will be asked about your assets: what types of assets; the values of assets; how assets are titled; whether assets are controlled by beneficiary designations. Depending on your objectives, your attorney may guide you in revising the ownership of your assets or your beneficiary designations.