It’s no secret that the topic of estate planning can be a daunting one. Not only are you having to consider your own health and mortality, and that of your loved ones, but you also have to navigate a complicated world of legal and tax terminology that seems ever-changing. It’s no wonder that many clients avoid the topic altogether, or if they do create an estate plan, they are reluctant to review and update it because they don’t want to go back through that process. Forvis Mazars Private Client™ understands, and we’re here to help you understand some of the concepts of estate planning so you can discuss them with your advisors.
One of the most basic pieces of an estate plan for clients is the utilization of Marital/Family Trust planning. Think of this as estate planning 101 for clients with a potentially taxable estate. This type of planning also can be referred to as A/B Trust planning or Marital/Credit Shelter Trust planning. Despite the variation in names, the concept and the potential tax benefits are the same.
Background
Federal Estate Tax & Exemption Amount
Let’s start with some basic information on the federal estate tax, and why it can be an important part of the planning in your overall estate plan. When a citizen or resident of the U.S. dies, there is a federal estate tax that applies to the value of their estate, and this tax can be as high as 40%. In calculating the estate tax, there is an estate tax exemption that excludes a certain amount of the estate from taxation. In 2022, the exemption amount was $12.06 million, meaning that estates under this amount would not owe any federal estate tax. This exemption is indexed each year for inflation, so the exemption has increased in 2023 to $12.92 million. That means that in 2023, with some careful planning, a married couple can pass up to $25.84 million to their heirs estate tax free. Unfortunately, under the current law, the exemption amount will sunset in 2026 and return to the 2010 exemption amount of $5 million (indexed for inflation through 2026) per person.
Using a Family Trust
Crafting an estate plan that provides for funding of a Family Trust at the first death allows for use of the available lifetime exemption at the first spouse’s death. The Family Trust is generally funded first to the extent of the available credit, with the remaining assets passing to the surviving spouse outright or in a Marital Trust, avoiding estate tax at the first death.
The use of the Family Trust provides a benefit by allowing assets to be available for family members and sheltering growth on assets held in the Family Trust between the first and second death from estate tax.
Marital Deduction
Another important aspect of the federal estate tax is the unlimited marital deduction. This allows your estate to be exempt from tax on any amount of assets left to your spouse. You can leave these assets outright, or you can leave them in trust for the benefit of your spouse. If you leave them in trust, however, there are specific rules that those trusts must follow to qualify for the unlimited marital deduction. For example, all trust income must be distributed to the surviving spouse annually to qualify for the marital deduction. These trusts are generally called “Marital Trusts.” Sometimes, depending on the terms of the trust, they also are called Qualified Terminable Interest Property Trusts, or QTIPs. Regardless of the name, the primary purpose behind these trusts is to avoid paying estate taxes at the death of the first spouse. There are some other benefits to these trusts, which we’ll discuss in the second article in this series. When the second spouse dies, the value of the Marital Trust will be included in their taxable estate for federal estate tax purposes.
Example:
Let’s walk through an example to help illustrate.
James and Mary are married and have three adult children. They have an estate valued at $40 million, and they each own 50%. James died in 2022, and his will leaves everything outright to Mary so there is no estate tax due at his death. She now has an estate valued at $40 million. Let’s assume that Mary dies in 2030 and leaves everything to their three children. We also will assume that Mary’s estate grew at a flat 5% per year from 2022 to 2030, so in 2030 it had grown to approximately $59.1 million. This full amount, minus whatever the estate tax exemption will be in 2030, will be subject to the federal estate tax.
Now, let’s assume James and Mary had executed wills that incorporated Marital Trust and Family Trust planning. At James’ death, the Family Trust would have been funded with his estate tax exemption amount of $12.06 million, sheltering it from tax at Mary’s death. The balance of James’ estate would pass to a Marital Trust, so there would be no estate tax due at his death. Using the same assumed growth rate of 5%, and assuming Mary dies in 2030, her taxable estate consisting of her initial $20 million in assets, and the assets passed to her in the Marital Trust, would be approximately $41.28 million. By executing wills with tax planning, James and Mary would be able to shelter James’ exemption amount plus all of the growth in the Family Trust between James’ death and Mary’s, approximately $5.76 million, from estate tax.
| Without Family Trust | With Family Trust | |
|---|---|---|
| Subject to Estate Taxes at James’ death | $0 | $0 |
| Subject to Estate Taxes at Mary’s death | $59,100,000 | $41,280,000 |
| Exemption available at Mary’s death | James’ unused exemption of $12,060,000 plus Mary’s exemption at her death | Mary’s exemption at her death |
* Without Family Trust planning, Mary’s estate will be subject to tax on an additional $5.76 million.
Note: For purposes of this discussion and illustration, assume that without the use of the Family Trust, James’ estate would elect portability to pass his unused exemption to Mary. For further discussion on portability, see “Marital/Family Trust Planning (Part 2).”
As you can see from the example above, there can be some significant estate tax benefits to incorporating Marital/Family Trust planning into your overall estate plan.
Other Benefits of Marital/Family Trust Planning
Aside from the potential estate tax benefits we discussed above, placing assets into a trust can provide some additional benefits to you and your family. Here are some of those benefits:
- Protects assets from creditors – Since Marital/Family Trust assets are owned by the trust and not by the beneficiaries outright, the assets aren’t subject to the beneficiaries’ creditors. This means that assets held in the trusts are generally protected from divorce courts, bankruptcy courts, and plaintiff lawyers. Note that this protection isn’t available for assets held in a revocable trust.
- Assets held in trust avoid probate – Assets held in trust don’t go through the court-supervised process of probate at the death of the beneficiary. This not only reduces legal fees and the administrative burdens of administering an estate, but it provides additional privacy since you’re not going through a public court process. For further discussion on the benefits of using trusts to avoid probate, see “Trust Me: An Exploration into Trusts.”
- Flexibility in drafting the trust document – Trust language can generally be as vague or detailed as the client wishes. This allows the client to limit the beneficiaries’ access to the assets to the extent desired depending on the type and ultimate goal of the trust. It also is possible to provide beneficiaries with a limited power of appointment to leave assets to specific heirs or charities of their choosing at their deaths.
- Reduces asset transfer tax burden for future generations – If the trusts are set up properly, the beneficiaries won’t pay any estate taxes or generation-skipping transfer taxes at their death.
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