Understanding Marital Deduction Trusts

Transcription

1 Understanding Marital Deduction Trusts

2 Understanding Marital Deduction Trusts DISCUSSION TOPICS What is a Marital Deduction Trust? How Does a Marital Deduction Trust Work? Special Considerations Regarding a Marital Deduction Trust What are the Advantages of a Marital Deduction Trust? INVEST Trust Services The purpose of a Marital Deduction Trust is simple your should be able to pass your estate (your property and assets) that you own at the time of your death to your surviving spouse without the property being subject to Federal Estate Tax liability. What is a Marital Deduction Trust? A Marital Deduction Trust is an irrevocable Personal Trust that is defined in Section 2056 of the Internal Revenue Code ( IRC ). It provides for the exclusion of estate death taxes at the time of the first spouse s death; and is commonly known as the Marital Deduction Trust, the A Trust, or QTIP Trust. It is most often created by your Will (through pour over provisions ) or through provisions in your Living Trust. It is intended to hold assets for the benefit of your surviving spouse. The purpose of a Marital Deduction Trust is simple you should be able to pass your estate (your property and assets) that you own at the time of your death to your surviving spouse without the property being subject to Federal Estate Tax liability. In keeping with this idea, the federal estate tax laws allows your estate to take advantage of an estate tax exemption by granting an unlimited marital deduction from any estate tax liability your estate may have if you pass all of your assets to your surviving spouse. However, significant future tax benefits of this tax free deduction are lost if not protected in the Trust. There are several requirements that must be included in the Trust Agreement in order for a Marital Deduction trust to be valid. The marital deduction may only be taken for transfers of property between spouses. Whether a couple is married or not is determined under your residency state laws. While the Marital Deduction can be utilized for transfer during your lifetime, for transfers at death, the marital deduction applies only to property included in your gross estate for federal estate tax purposes. This makes sense since only that property is potentially subject to tax at your death. The marital deduction is generally available for federal estate tax exemption to estates of U.S. citizens where the surviving spouse is also a U.S. Citizen. Where the surviving spouse is not a U.S. citizen, the marital deduction is generally only available if the property is in a qualified domestic trust. To qualify for the marital deduction, the property that passes to your surviving spouse must not be a terminable interest. That is, your spouse s interest in the property must not be subject to expiration due to the passage of time, the occurrence of some future event, or the failure of some future event to occur. If any of these things can happen, then your spouse is said to have a disqualified terminable interest.

3 How Does a Marital Deduction Trust Work? During the surviving spouse s lifetime, the property or assets in the Trust (the trust principal ) are intended to generate income and support for the surviving spouse. When the first spouse dies, the assets specified by the first spouse pass to the Marital Deduction Trust free and clear of all federal estate taxes liability. During the surviving spouse s lifetime, the property or assets in the Trust (the trust principal ) are intended to generate income and support for the surviving spouse. However, the surviving spouse has unconditional access to the Trust principal if the income is insufficient to take care of his/her Maintenance, Education, Support and Health Needs ( MESH ). Assets held inside of the Marital Deduction Trust are managed by a Trustee who has the legal responsibility for managing and overseeing the trust assets to provide adequate support for the surviving spouse and to distribute the Trust principal to the named heirs in accordance with the terms and conditions of the Trust agreement. When your surviving spouse dies, the assets in the Marital Deduction Trust are not included as part of her/his estate, and so his/her federal estate taxes are not as high as they would have been if there had been no trust. That is why you should split your estate between you and your spouse in terms of ownership of the property and assets. The assets owned by the surviving spouse, outside of the Marital Deduction Trust, may pass free of federal estate tax liability if their value qualifies for the surviving spouse s personal federal tax exemption. For the Trust to qualify for the marital deduction, the surviving spouse: Must be the only beneficiary of the Trust during his/her lifetime. That is, he or she is the only person who receives income or principal distributions from the Trust for as long as he or she lives. Must be given either the unrestricted power to give away the Trust assets when he or she dies or All of the income that the Trust earns must be given to the surviving spouse at least annually during her/his lifetime, with the Trust specifying who gets the Trust assets when the surviving spouse dies. This is called a QTIP provision or a Qualified Terminable Interest Property Marital Deduction Trust.

4 A QTIP trust is frequently used in the case of second marriages where one or both spouses have children from a previous marriage and each spouse wants to provide for the new spouse, but also wants to be certain that his or her children will receive the trust assets on the surviving spouse s death. The QTIP provision in the Marital Trust agreement will usually provide that when the surviving spouse dies, whatever is left over in the Marital Trust is to pass to the Trust creator s children or grandchildren. The QTIP provision does not allow the surviving spouse to change or alter the terms or amounts that are to be given to the first spouse s children or grandchildren that are alive when the surviving spouse dies. The surviving spouse s interest or benefits under the Trust cannot be terminated. That is, you cannot specify in the Trust that his/her benefits will cease if he/she remarries. Special Considerations Before you decide if a Marital Deduction Trust is right for your estate plan you need to have a serious discussion with a qualified estate planning attorney. Before you decide if a Marital Deduction Trust is right for your estate plan you need to have a serious discussion with a qualified estate planning attorney. While it is true that a Marital Deduction Trust offers an attractive feature in the reduction or elimination of federal death taxes, a Marital Deduction Trust should only be utilized after you take into consideration some of the negative effects it could have on your surviving spouse or on your estate plan. In order for the Trust to qualify for the federal estate tax exemption it must place very restrictive conditions on your surviving spouse. Since it is irrevocable, the terms and conditions of the Trust cannot be changed by your surviving spouse; or by you should you create it and fund it during your lifetime. (Assets passed into the Trust during your lifetime do qualify for the full marital deduction). A Marital Deduction Trust should not be considered if after funding the Trust the remaining assets of your estate are very few and improper for supporting your surviving spouse. Too many times an individual creates estate planning documents that automatically provide for the individual s estate to fund a Credit Shelter and a Marital Deduction Trust. However, if your combined estate would pass estate tax free, or with a very low amount subject to federal estate tax, at the time of your surviving spouse s death, then it may not be advantageous to create a Trust that would provide severe consequences on the ability of the surviving spouse to maintain the lifestyle that he/she wants.

5 For a young couple, a Marital Deduction Trust normally would not be the first choice in their estate plan. The older the couple is the more probability the Marital Deduction Trust will be a consideration. Normally, the estate is not as large for a young couple than an older couple. Many time, the younger the couple the more probability there will be children, or young adults, that the surviving parent will need to provide for without facing the restricted access that the Marital Deduction Trust imposes on the surviving spouse. Regardless of the potential tax reduction, the welfare of the surviving spouse must always dictate the need or use of a Marital Deduction Trust. Another serious problem can occur if a Marital Deduction Trust is established by an individual and funded during his/her lifetime. The terms, conditions and beneficiaries of the irrevocable trust cannot be changed once it is created and funded. If an individual divorces his current wife, and remarries, the second surviving spouse will not benefit from the assets and income produced by the Credit Shelter Trust. Of course the Trust language can simply name the individual that is to benefit by using language in the Trust that states, my surviving spouse. But all too often the documents are executed with specific names of the spouse and in that regard, whether they are your spouse at death, the Trustee must manage the Trust for the named beneficiaries.

6 Advantages of a Marital Deduction Trust No federal estate tax liability is incurred on property and assets at the first and second spouse s deaths. The trust receives a stepped-up basis for income tax purposes on property qualifying for the marital deduction. Thus, if the property is subsequently sold, there will be less capital gains taxation. When the marital deduction is properly coordinated with other estate planning tools, combined federal estate tax liability in both spouses estates can be minimized. INVEST Trust Services offers a complete suite of trust services. INVEST Trust Services is a Trust Representative Office of National Advisors Trust Company, NATC. The Trust Company is one of the largest independent trust companies in the nation. It is governed by the Office of Thrift Supervision, ( OTS ), a bureau of the U.S. Treasury Department. The Trust Company is also a member of the Federal Deposit Insurance Corporation ( FDIC ). By law, the Trust Company segregates all trust account assets from the capital assets of the Trust Company, ensuring they are never subject to potential creditor claims against the Trust Company. The Trust Company has a professional team of experienced trust executives that will serve all of your trust needs. Please contact your Trust Relationship Manager at INVEST Trust Services for more information. This information is general in nature and should not be construed as tax or legal advice. INVEST Trust Services does not provide tax or legal advice. Please consult your tax and/or legal adviser for guidance on your particular situation. Personal Trust Services Revocable Trusts Charitable Trusts Irrevocable Life Insurance Trusts Special Needs Trusts Irrevocable Trust transfers from other Corporate Trustees Marital Deduction Trusts Credit Shelter Trusts Bill Payment Accounts Investment Management accounts Retirement Plan Services IRAs Custodian or Trustee Defined Benefit Plans 401(k) Daily Valuation Platform Defined Contribution Plans Roth 401(k) Distribution processing and 1099R filings Contribution processing INVEST Trust Services is provided by INVEST Financial Corporation (INVEST), member FINRA/SIPC. INVEST is not affiliated with NATC or FiPar. Products offered through INVEST are: Not FDIC or NCUA insured Not Bank or Credit Union Guaranteed May lose value including loss of principal. 11bi

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