Marital Deduction & Bypass Trusts “A-B Trusts”

1. 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

2. 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

3. Unified Credit Schedule GIFT TAX UNIFIED CREDITESTATE TAX UNIFIED CREDIT Exemption Unified Exemption Unified YearEquivalentCreditYearEquivalentCredit 2002-2009 $1,000,000 $345,8002006-2008 $2,000,000 $ 780,800 2010 $1,000,000 $330,8002009 $3,500,000 $1,455,800 2011 $5,000,000 $1,730,8002010 $5,000,000 $1,730,800 2011 $5,000,000 $1,730,800

4. 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

5. 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

6. 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

7. 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

8. 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.

9. When Is The Use Of A Marital Deduction & Bypass Trust Appropriate? Spouses desire: • Survivor to have full economic benefit (not ownership) of family’s wealth, and • 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

10. 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

11. 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

12. What Are The Requirements? (cont’d) Power Of Appointment Trust: • Surviving spouse right to all income produced by the trust • Income produced by trust payable at least annually • Surviving spouse given general power of appointment during life, at death, or both • Power exercisable by surviving spouse in all events • No person has power to appointment any part of trust to anyone other than surviving spouse

13. What Are The Requirements? (cont’d) Estate Trust: • Income to surviving spouse for life (payable to, or accumulated for, surviving spouse’s benefit) • 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

14. What Are The Requirements? (cont’d) QTIP Trust: • All income payable to surviving spouse at least annually • Trust does not need to grant surviving spouse power of appointment • No power to shift any of the trust property to anyone other than surviving spouse during spouse’s lifetime • Spouse power to require trustee to make the assets produce income • Executor must elect QTIP treatment on decedent spouse’s estate tax return

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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