Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Marital Deduction & Bypass Trusts “A-B Trusts”
• Gives surviving spouse full use of family’s wealth
• Minimizes total federal estate tax payable at the death
of both spouses
• Usually eliminates federal estate taxes at the death of
the first-to-die of the spouses by capitalizing on the
coupling of the:
– Marital deduction
– Unified credit
Copyright 2011, The National Underwriter Company
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Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Marital Deduction & Bypass Trusts “A-B Trusts”
(cont’d)
• Avoid overqualification for the marital deduction
because of underutilization of unified credit of the first
spouse to die
Copyright 2011, The National Underwriter Company
2
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Unified Credit Schedule
GIFT TAX UNIFIED CREDIT
Exemption Unified
Year
Equivalent
Credit
2002-2009 $1,000,000 $345,800
2010
$1,000,000 $330,800
2011
$5,000,000 $1,730,800
Copyright 2011, The National Underwriter Company
ESTATE TAX UNIFIED CREDIT
Exemption
Year
Equivalent
2006-2008 $2,000,000
2009
$3,500,000
2010
$5,000,000
2011
$5,000,000
Unified
Credit
$ 780,800
$1,455,800
$1,730,800
$1,730,800
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Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
How It Works
• A-B Trust Plan
– Fund the bypass trust with amount equal to remaining unified credit
exemption equivalent amount
• Tax on these assets will be offset by the unified credit
• Bypass trust assets and their appreciation will not be taxed again for
estate purposes at the surviving spouse’s death
• Spouse typically receives income for life from these assets
• Spouse may also be given a limited power or power to take the greater of
$5,000 or 5% of the trust principal
– Fund the marital trust with the balance of the estate
• Marital trust assets pass estate tax-free to the spouse using the unlimited
marital deduction
• Marital trust assets will be taxed at the surviving spouse’s death
Copyright 2011, The National Underwriter Company
4
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
How It Works (cont’d)
• A-B-Q Trust Plan
– Works the same way as the A-B trust plan, except all
or a portion of the assets passing to the surviving
spouse may be held in a trust known as a qualified
terminable interest property (QTIP) trust
• In a QTIP trust, the surviving spouse gets income for life,
but the first spouse to die controls where the property goes
after the second spouse’s death
• Often the surviving spouse is given a limited power of
appointment over the assets in the QTIP trust to appoint
differing amounts to the various predetermined beneficiaries
Copyright 2011, The National Underwriter Company
5
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
How It Works (cont’d)
• Other types of marital trusts
– General power of appointment with mandatory income to
spouse: Surviving spouse can appoint the property to
whomever the spouse wishes including himself, his creditors,
his estate, or the creditors of his estate
– Estate trust: Mandatory income to surviving spouse and
remainder passes to spouse’s estate at spouse’s death
Copyright 2011, The National Underwriter Company
6
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Revocable A-B-Q plan with life insurance trust
coupled with a “pour over will”
– Created during grantor’s lifetime
– Can be torn up or changed anytime during life
– Trustee of life insurance trust is named beneficiary
of life insurance issued on grantor’s life
– Will provision that states grantor’s residuary estate
(net payment of debts, expenses, taxes and
specific bequests) be “poured over” into the life
insurance trust
Copyright 2011, The National Underwriter Company
7
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Revocable A-B-Q plan with life insurance trust
coupled with a “pour over will” (cont’d)
• After funding, the trust is divided into two or three
parts:
– Marital or “A” Trust
– Bypass “B” or Family Trust
– QTIP Trust
• Trust provides flexibility, while minimizing taxes and
meeting long term family goals
Note: The revocable trust may hold other assets besides life insurance,
prior to grantor’s death, in order to avoid probate for those assets. All of the
trust assets will still be included in the grantor’s gross estate for the estate
tax calculation.
Copyright 2011, The National Underwriter Company
8
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
When Is The Use Of A Marital Deduction & Bypass
Trust Appropriate?
Spouses desire:
1. Survivor to have full economic benefit (not ownership) of
family’s wealth, and
2. Minimize the aggregate death taxes payable at the death of
both spouses
Want to avoid overqualification of assets for marital
deduction (Don’t want to waste the unified credit of first spouse to
die)
Where couples plan to set up generation-skipping transfer
trusts
Favorable state inheritance tax may be obtained
Copyright 2011, The National Underwriter Company
9
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
When Is The Use Of A Marital Deduction & Bypass
Trust Appropriate? (cont’d)
• Management of trust property is needed for surviving
spouse or other beneficiaries
• Desire to avoid probate
• One spouse is a non-U.S. citizen
• First spouse to die wants to benefit surviving spouse
and ensure that remaining assets will go to children
• Desire flexibility until the first spouse’s death whether
to pay some estate tax at that time
Copyright 2011, The National Underwriter Company
10
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
What Are The Requirements?
In General:
– Assets in the marital trust must pass to or be held for the
benefit of the person married to the decedent at the time of
decedent’s death
– In documents creating the marital trust, insert a survivorship
clause creating a presumption that for purposes of the
marital deduction the spouse is deemed to have survived in
the event of a simultaneous death
Copyright 2011, The National Underwriter Company
11
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
What Are The Requirements? (cont’d)
Power Of Appointment Trust:
1. Surviving spouse right to all income produced by the trust
2. Income produced by trust payable at least annually
3. Surviving spouse given general power of appointment
during life, at death, or both
4. Power exercisable by surviving spouse in all events
5. No person has power to appointment any part of trust to
anyone other than surviving spouse
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12
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
What Are The Requirements? (cont’d)
Estate Trust:
1. Income to surviving spouse for life (payable to, or
accumulated for, surviving spouse’s benefit)
2. Remainder of trust (principal + accumulated income) payable
to surviving spouse’s estate at surviving spouse’s death
When to Use:
– Desire or need to invest in non-income producing property
– Survivor will not need trust assets or income during survivor’s
lifetime, and
– Property placed in trust is not likely to appreciate substantially
in value
Copyright 2011, The National Underwriter Company
13
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
What Are The Requirements? (cont’d)
QTIP Trust:
1. All income payable to surviving spouse at least annually
2. Trust does not need to grant surviving spouse power of
appointment
3. No power to shift any of the trust property to anyone other than
surviving spouse during spouse’s lifetime
4. Spouse power to require trustee to make the assets produce
income
5. Executor must elect QTIP treatment on decedent spouse’s
estate tax return
Copyright 2011, The National Underwriter Company
14
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
What Are The Requirements? (cont’d)
QTIP Trust (cont’d)
When to Use:
– Desire amount in excess of unified credit exemption
equivalent to qualify for the marital deduction at the first
spouse’s death
– Do not want surviving spouse to hold a general power of
appointment over marital trust assets
Copyright 2011, The National Underwriter Company
15
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Electing to Pay Some Tax
• Tax savings can be realized by paying taxes early if
property increasing in value
• If asset is worth $100,000 at first spouse’s death and
expected to appreciate to $500,000 by second spouse’s
death, may be better to pay estate tax on $100,000
rather than on $500,000
• This is where a QTIP and disclaimer provisions and
elections can add some flexibility in estate tax planning
Copyright 2011, The National Underwriter Company
16
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Reverse QTIP Election
• For 2011-2012, the generation-skipping exemption
equals the federal estate tax unified credit exemption
equivalent
– In the typical A-B plan, the bypass trust will receive the full
GST allocation
– If no lifetime gifts have been made, no reverse QTIP is
necessary
– If gifts have been made during lifetime, GST exemption and
estate tax unified credit exemption equivalent may be
unequal at death
Copyright 2011, The National Underwriter Company
17
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Reverse QTIP Election (cont’d)
• QTIP election qualifies transfer from decedent
spouse to surviving spouse for estate tax marital
deduction
– QTIP property will be included in surviving spouse’s estate
• With reverse QTIP election, decedent spouse treated
as transferor for generation-skipping transfer tax
purposes
– Avoid waste of GST exemption of first spouse to die where
GST exemption and estate tax unified credit exemption
equivalent are unequal at death
Copyright 2011, The National Underwriter Company
18
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Issues In Community Property States
• Remember ½ of the property already belongs to the
surviving spouse
– This property is usually not subject to the provisions of
decedent’s will
– If spouse elects to retain their ½ interest in property, then
management of the property is split with trustee of the marital
trust
– If spouse’s property passes through decedent’s will, then it
usually pours into a power of appointment marital “A” trust
Copyright 2011, The National Underwriter Company
19
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Jointly Owned Property
• Owning property as joint tenants with right of
survivorship or as tenants by the entirety between
spouses will cause the property to pass outside of the
decedent’s probate estate and not be available to fund
the bypass “B” family trust
– May result in underutilization of first spouse’s exemption
– Property passing to surviving spouse tenant will qualify for the
marital deduction
Copyright 2011, The National Underwriter Company
20
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Disadvantages of A-B/A-B-Q Trust
• If trusts are currently funded, trustee fees may need to
be paid
– Avoid trustee fees by grantor acting as trustee
• After death of grantor, surviving spouse cannot have
unlimited control or access to assets in nonmarital
trust(s)
– Give spouse mandatory income at least annually
– Give trustee discretion to distribute principal to surviving
spouse per an ascertainable standard
– Give spouse 5 or 5 withdrawal power
– Give spouse limited testamentary power of appointment
Copyright 2011, The National Underwriter Company
21
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Advantages of Estate Trust vs. Power of
Appointment Trust
• Estate trust does not require all income to be paid out
to surviving spouse, some can be accumulated in the
trust
• May make it easier to retain non-income producing
assets in the trust
Copyright 2011, The National Underwriter Company
22
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Advantages of Marital Deduction Passing to
QTIP Trust
• Flexibility for trustee to determine how much of the
trust should be taxed at the death of the first spouse
• Grantor can be certain that at the death of the
surviving spouse, property will go where grantor
wanted it to go, not to survivor’s new friend or spouse
• Only optimum marital arrangement allowing:
– Grantor’s full GST exemption to be preserved, while
– Property still benefits surviving spouse during life, and
– No estate tax is due at grantor’s death
Copyright 2011, The National Underwriter Company
23
Marital Deduction and Bypass
Trusts
Chapter 24
Tools & Techniques of
Estate Planning
Which Funding Formula Is Preferable?
• It depends on the type of assets the grantor owns
– If probability of substantial increase in value during settlement
period of trust or estate  Pecuniary formula clause giving
residual amount to the bypass trust
– If possibility of drop in estate value  Pecuniary formula
specifying exact amount to bypass and residual to marital trust
– Fractional share clause
• Avoids recognition of income tax gain upon transfers to a trust
• Shifts increase or decrease proportionately to both marital
deduction and bypass trusts
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24