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Living trusts enable you to control the distribution of your estate, and certain trusts may enable you to reduce or avoid many of the taxes and fees that will be imposed upon your death.
A trust is a legal arrangement under which one person, the trustee, controls property given by another person, the trustor, for the benefit of a third person, the beneficiary. When you establish a revocable living trust, you are allowed to be the trustor, the trustee, and the beneficiary of that trust.
When you set up a living trust, you transfer ownership of all the assets you’d like to place in the trust from yourself to the trust. Legally, you no longer own any of the assets in your trust. Your trust now owns these assets. But, as the trustee, you maintain complete control. You can buy or sell as you see fit. You can even give assets away.
Upon your death, assuming that you have transferred all your assets to the revocable trust, there isn’t anything to probate because the assets are held in the trust. Therefore, properly established living trusts completely avoid probate. If you use a living trust, your estate will be available to your heirs upon your death, without any of the delays or expensive court proceedings that accompany the probate process.
There are some trust strategies that serve very specific estate needs. One of the most widely used is a living trust with an A-B provision. An A-B trust (also known as a bypass trust) enables a married couple to pass on up to double the exemption amount to their heirs free of estate taxes.
However, with enactment of the 2010 Tax Relief Act, some couples may no longer need an A-B trust to maximize the estate tax exemption for both spouses. But before you make a decision about the use of a bypass trust, there are a number of issues to consider.
First a little background on changes in the estate tax as a result of the 2010 Tax Relief Act. The law increased the applicable exemption amount to $5 million retroactively to January 1, 2010, with a 35 percent tax rate. The increased threshold alone eliminates many people from being subject to the federal estate tax. An interesting new provision is “portability” of the exemption to the surviving spouse, which allows surviving spouses to use their spouses’ unused exemption plus their own, enabling a couple to exempt up to $10 million from federal estate taxes.
However, provisions of the 2010 Tax Relief Act are in effect only through December 31, 2012, unless Congress amends or extends the law. So in 2013, not only does the portability provision expire but the federal estate tax exemption is scheduled to fall from $5 million to $1 million, which would subject many more households to the federal estate tax. Furthermore, many states have their own estate or inheritance tax, or both, and none currently has portability provisions. This means that when married couples leave all their assets to their spouses, the surviving spouse will be able to use only his or her state exemption. Additional considerations favoring a trust are the ability to shelter appreciation of assets placed in the trust, to protect assets from creditors, to benefit children from a previous marriage, and to preserve a married couple’s state estate tax exemptions.
When an A-B trust is implemented, two subsequent trusts are created upon the death of the first spouse. The assets will be allocated between the survivor’s trust, or “A” trust, and the decedent’s trust, or “B” trust. This will create two taxable entities, each of which will be entitled to use a personal exemption.
The surviving spouse retains full control of his or her trust. He or she can also receive income from the deceased spouse’s trust and can even withdraw principal from it when necessary for health, support, or maintenance.
On the death of the second spouse, the assets of both trusts pass directly to the heirs, completely avoiding probate. If each of these trusts contains less than the exemption amount, these assets will pass to the heirs free of federal estate taxes.
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