DO YOU STILL NEED A LIVING TRUST IF THE ESTATE TAX IS PERMANENTLY ABOLISHED?

With the talk of abolishment of the estate tax, many clients are confused as to whether they still need to go through the hassle of setting up a living trust.  Even in the unlikely event that the federal estate tax is wholly eliminated, however, there are still many advantages to establishing a living trust. 

First and foremost, you want to avoid probate.   If you die without a will (intestate) or with a will but no living trust, your property must be probated.  Probate is a process whereby the court supervises the administration of your estate, i.e., decides to whom your property will pass either through a will or by the laws of intestate succession.  As anyone who has experienced it will tell you, probate can be a nightmare.  It is time consuming and expensive.  The probate process is also a matter of public record so anyone can be privy to your affairs. 

A living trust is a great way to avoid probate. Basically, you transfer your assets to the trust while you are alive and make yourselves (or someone you trust) the trustees of the trust.  The trustees then administer the assets of the trust while you are alive pursuant to your wishes and then continue to administer these assets after your death.  As a result, when you die, ideally, there is nothing in your name to probate.
As a result, the short answer to the question posed above is YES, A LIVING TRUST IS A GOOD IDEA EVEN IF THE ESTATE TAX GOES AWAY. 

OTHER ADVANTAGES TO A LIVING TRUST

In addition, with the government scrambling to pay for disasters such as Hurricane Katrina, many doubt that Congress will go for total abolishment of the estate tax.  In the event the estate tax is not repealed, if structured right, a trust may save your estate money in federal taxes by making full use of your individual exemption amounts.  Presently (in 2006), you can pass up to 2 million dollars to your heirs free of estate tax.  Ordinarily, when you pass property to your surviving spouse, all of your property is included in your estate for federal estate tax purposes.  However, your spouse is allowed to use what’s called a “marital deduction” so that no estate tax is due when you die.   While this is great for the time being, down the road, that same property will be subject to estate tax when the surviving spouse dies.  Basically by using the marital deduction, you have wasted the use of the individual exemption amount. 

With proper planning, however, you can utilize both individual exemptions amounts.  This is done by having some of your property pass to a “Bypass Trust”, the assets of which are not eligible for the marital deduction.

In the typical estate plan for a married couple, on the first spouse’s death, the property will be allocated to three trusts.  Half of the community property assets and all separate property assets of the surviving spouse will go into what is called the Survivor’s Trust (i.e., Trust “A”).  The survivor will be allowed to do with this property whatever he or she wishes including the power to gift or devise it to whomever they want. 

The “B” trust (called the Bypass Trust) will consist of an amount equal to the applicable exemption amount for that year usually calculated with reference to a particular formula.  (If someone died in 2006, for example, the Bypass Trust would be funded with approximately $2,000,000.)  The reason it is called the Bypass Trust is that this amount of money will be included in the Decedent’s estate (the first dead person) for federal estate tax purposes, but will not be eligible for the marital deduction.  Because it will only consist of the applicable exemption amount, however, the survivor will not pay any federal estate tax on this amount.  The survivor will have what’s called a life estate in the Bypass Trust which will include the right to income from the Bypass Trust and power to invade the principle under certain ascertainable standards, i.e., for health, education and welfare.  Because the surviving spouse only has a life estate, however, nothing passes when the survivor dies so this amount bypasses the survivor’s estate.  As a result, you have saved a significant amount of money in federal estate taxes. 

The “C” Trust (called the “Marital Trust”) will consist of the balance of the estate. Again, the surviving spouse will have a life estate in the “C” Trust with power to invade principle under certain ascertainable standards.  As to this trust, the executor will most likely make a “Q-Tip election” which will qualify these assets for the marital deduction.  The election is basically an agreement by the surviving spouse that he or she will include those monies in the surviving spouse’s estate when he or she dies.  

Aside from fully utilizing both exemptions, this type of structure has the added advantage of limiting the surviving spouse’s ability to give away the property in the “B” Trust. Through use of this arrangement, the spouse that is first to die has more control over where his or her estate passes ultimately.

For all these reasons, a living trust remains a great estate planning tool. Please contact TWLF for more information.

Any written advice provided by us is not intended to be used for the purpose of avoiding penalties that may be imposed on you as a taxpayer and cannot be used by a taxpayer for such purpose. In addition, if any advice provided by us is used or referred to in promoting, marketing, or recommending any tax transaction or matter, such advice should not be construed as written to support the promotion or marketing of such transaction or matter and the recipient should seek advice from an independent tax advisor regarding the taxpayer's particular circumstances.