The United States imposes a tax (called the estate tax) on the estate of a deceased person who dies in 2018 – 2025 whose net worth exceeds $11,180,000 adjusted for inflation. The estate tax is 40% of the value of the deceased person’s net estate that exceeds the federal estate tax exemption amount in the year of death. The exemption amount for people who die in 2018 – 2025 is $11,180,000 before adjusting for inflation. For example, if your net worth (total asset value – debts) is $15,000,000 and you die in 2018, your estate must pay the IRS $1,528,000 [($15,000,000 – $11,180,000) x .40] nine months after your death.

Unless Congress changes the estate tax exemption amount it will become $5,490,000 adjusted for inflation for people who die after December 31, 2025.

If you are married your taxable estate will be reduced by the value of the assets you leave to your spouse. In the above example if the entire $15,000,000 went to the spouse of the deceased person the estate of the deceased person would not owe any federal estate tax. The $15,000,000 left to the surviving spouse avoids federal estate tax until the death of the surviving spouse when it is included in the value of the estate of the second spouse to die.

Warning: Leaving the entire amount to the surviving spouse outright would be a mistake because it could cost the family who inherits the $15,000,000 after the death of the surviving spouse megabucks in federal estate taxes that could be eliminated if the first spouse to die had created a trust that contains federal estate tax minimization provisions. Married couples whose combined net worth exceeds the exemption amount ($11,400,000 currently) applicable in the year of death need a trust with estate tax saving provisions to eliminate or reduce federal estate taxes on the death of the second spouse.

Example of How a Trust with Estate Tax Planning Provisions can Eliminate or Minimize Federal Estate Taxes

The remainder of this chapter explains how a properly designed revocable living trust with estate tax planning provisions can eliminate or minimize federal estate taxes on the death of the first spouse and the death of the second spouse. The bottom line is that a trust with estate tax planning provisions can save your family 40% of every dollar of net worth over $11,400,000. That equates to $400,000 of money that goes to your loved ones instead of the IRS for every $1,000,000 of net worth over $11,400,000. If you and your spouse have a combined estate that exceeds $11,400,000 including the amount of life insurance on your life and your spouse’s life YOU MUST CREATE A TRUST WITH ESTATE TAX PROVISIONS IN IT!!!

Estate Taxes on Life Insurance Proceeds

In calculating the value of a person’s estate the IRS adds the amount of all life insurance proceeds on the life of the deceased person unless the deceased person does not have any “incidents of ownership” with respect to the life insurance policy. For more on this important topic read Chapter 15 How To Prevent The IRS from Getting 40% of Life Insurance.

Example: Total Value of Husband and Wife’s Estate = $25,000,000 (1st Spouse Dies in 2019 - 2025)

A married couple created a revocable living trust that owns a $500,000 home, $400,000 in investment accounts, $24,000,000 in the family business and miscellaneous items worth $100,000, all of which is community property.

What Happens after the First Spouse Dies

As soon as practicable after the death of the first spouse the trustee (usually the surviving spouse unless he/she is incompetent or resigns as trustee), must divide the trust into two trusts and transfer assets into each of the trusts. These trusts are the Survivor’s Trust, the Family Trust and the QTIP Trust (aka the A, B & C trusts). The trustee must value all of the assets of both spouses then allocate to each trust sufficient assets that causes the correct dollar value of assets to be owned by each trust.

QTIP is an abbreviation for “qualified terminable interest trust,” which is a term from the Internal Revenue Code.  It means a trust created to hold assets of a deceased spouse solely for the benefit of the deceased person’s spouse and that requires that all annual income of the trust be distributed to the surviving spouse.

What Assets Go into the Survivor’s Trust?

The trustee must transfer to the Survivor’s Trust property that has a value equal to the total value of the Survivor’s separate property and ½ of the community property.

What Assets Go into the Family Trust?

The trustee must transfer to the Family Trust property that has a value equal to the total value of the deceased spouse’s separate property and ½ of the community property up to the amount of the federal estate tax exemption amount. As of January 1, 2019, the exemption amount for people who die in 2019 - 2025 is $11,400,000, which means that a maximum of $11,400,000 will be allocated and transferred to the Family Trust.

When the surviving spouse dies, the value of the assets held in the Family Trust are not included in the estate of the surviving spouse which means the assets in the Family Trust are free of federal estate tax regardless of the assets value.

What Assets Go into the QTIP Trust?

The trustee must transfer to the QTIP Trust property that has a value equal to the total value of the deceased spouse’s separate property and ½ of the community property minus $11,400,000 for people who die in 2019 - 2025.  In this example, the surviving spouse must transfer $1,320,000 of the deceased spouse’s asset to the QTIP trust.  All income earned by the QTIP Trust each year must be distributed to the surviving spouse.

How Does the Trustee Allocate Assets between the Three Trusts?

Unless the trust agreement specifies that specific property must be transferred to one of the three trusts, the trustee has the discretion to allocate assets to which ever trust the trustee believes is best. The trustee may allocate an asset to each trust and cause the two or three of the trusts to own a share of the asset as tenants in common.   The trustee can also allocate a parcel of real property worth $200,000 to the Family Trust and $200,000 of stock to the QTIP Trust.

Sample Allocation of $25,000,000 of Assets to the Three Trusts & Features of Each Trust (Death in 2019 - 2025)

Survivor’s Trust $12,500,000Family Trust $11,400,000QTIP Trust $1,320,000
Assets in the Trust

Assets with a dollar value equal to the total of survivor's separate property + 1/2 of the community property, which equals $12,500,000. This trust owns the home, the investment accounts and the miscellaneous items valued at $1,000,000 plus an interest in the family business valued at $11,500,000.

Assets with a dollar value equal to the total of the deceased spouse's separate property + 1/2 of the community property, but if the decedent's net worth exceeds $11,400,000 the excess value goes into the QTIP Trust.

The assets that go into the QTIP Trust have a value equal to the total value of the deceased spouse’s assets minus $11,400,000. The QTIP Trust owns assets with a value of $1,320,000 (total value of deceased spouse’s estate $12,500,000 - $11,400,000). The value of assets in the QTIP Trust is included in the estate of the surviving spouse on his or her death and may be subject to federal estate tax.

Revocable or Irrevocable

Revocable. Survivor has total control and may amend or terminate this trust, but the trust will become irrevocable if the survivor becomes incompetent or dies. Survivor may alter who will become a beneficiary after the survivor’s death.

Irrevocable. This trust may not be amended or terminated. The plan of distribution to the deceased spouse's loved ones is "set in stone."

Irrevocable. This trust may not be amended or terminated. The plan of distribution to the deceased spouse's loved ones is "set in stone."

Asset Protection

None. Because this trust is revocable, none of the assets in the Survivor’s Trust are asset protected from the spouse’s creditors. Use the money in this trust first because it is not asset protected.

Asset Protected. Because the Family trust is irrevocable, assets in this trust are protected from the beneficiaries' creditors, ex-spouses and predators. This feature is the primary benefit of creating this type of trust.

Asset Protected. Because the Marital Trust is irrevocable assets in this trust are protected from the beneficiaries' creditors, ex-spouses and predators.

Trustee

Surviving spouse is the trustee unless he/she is incompetent or resigns. Surviving spouse names one or more successor trustees to administer the trust if he/she becomes incompetent or dies.

Determined by the deceased spouse and specified in the trust agreement. Could be the surviving spouse unless he/she is incompetent or resigns, a trusted person or a bank or trust company.

Determined by the deceased spouse and specified in the trust agreement. Could be the surviving spouse unless he/she is incompetent or resigns, a trusted person or a bank or trust company.

Current BeneficiarySurviving spouse

Surviving spouse, but the deceased could have other beneficiaries such as children who are not the surviving spouse’s kids.

Surviving spouse
Distributions

Trustee may distribute any or all of the assets to the survivor or anyone else at any time.

Determined by the deceased spouse and specified in the trust agreement. The Trustee may have discretion to determine the amount and timing of distributions or distributions may be limited to the survivor’s health, education, maintenance or support. Don't use this money unless needed because it is asset protected and will not be taxed on the survivor’s death.

The Trustee must distribute annually to the surviving spouse all income earned during the year. The Trustee may distribute any or all of the principal to the surviving spouse in the Trustee’s discretion.

Future Beneficiaries

Selected by survivor. Usually assets go to children, but if a child is deceased the share of the deceased child goes to that child's living children and if none then equally to surviving siblings. Spouse can disinherit people.

Selected by the deceased spouse. Usually assets go equally to his/her children, but if a child is deceased the share of the deceased child would go to that child's living children and if none then equally to the surviving siblings.

Selected by the deceased spouse. Usually assets go equally to his/her children, but if a child is deceased the share of the deceased child would go to that child's living children and if none then equally to the surviving siblings.

Estate Taxes on 1st Death

$0

$0

$0

Estate Taxes on 2nd Death in 2019 - 2025

$1,056,000. Assumes estate value is $13,820,000 ($12,500,000 in the Survivor’s Trust + $1,320,000 in the Marital Trust).

None of the assets in the Family Trust will be taxed on the death of both spouses regardless of the value in the Family Trust.

Value of assets in the Marital Trust is included in the estate of the surviving spouse.