ABC Trust and GST (Generation Skipping Tax) Explanation
OBJECTIVE: (a) To utilize both the Massachusetts and Federal estate tax free amounts without creating an estate tax that would be payable by the surviving spouse.
(b) To utilize the Federal generation skipping tax exemption (GST exemption), which allows the next generation the ability to benefit from a trust that is protected from their creditors and is free of estate taxes when it transfers at their death to their children.
HOW THE TRUSTS ARE FUNDED AT THE DEATH OF THE FIRST SPOUSE:
- The Trustees fund the C trust first, with an amount equal to the amount that can pass free of estate taxes in Massachusetts. This amount also passes free of estate taxes for Federal purposes. (See chart attached for year by year changes.)
- Next the Trustees allocate the deceased spouse's GST exemption (or any amount remaining if the decedent used some of his or her GST exemption during their lifetime) to Trust C. If the available GST exemption is equal to or more than the value of Trust C, then only Exempt Trust C exists. If the available GST exemption is less than the value of Trust C, then you have an Exempt Trust C, equal to the available exemption amount and a Non-exempt Trust C, equal to the balance of what is in Trust C.
- The Trustees then fund Trust B. They fund Trust B with an amount, which when it is added to Trust C, equals the Federal amount that can pass free of the Federal estate tax. This Trust B is set up as a QTIP trust (Qualifying Terminable Interest Property trust). A QTIP trust is defined by the Internal Revenue Code. It is a trust that has the surviving spouse as the sole beneficiary. The Trustees must pay out all of the income from the trust to the spouse at least quarterly. In addition, the Trustees may pay principal of the trust only to the surviving spouse and the spouse must have the power to direct the Trustees to sell non-income producing property and re-invest in income producing property. The reason we use a QTIP trust is that it qualifies for an estate tax marital deduction if an "election" is made on the deceased spouse's estate tax return. This election qualifies the QTIP for marital deduction. Thus it is not taxable in the estate of the deceased spouse, but is taxable in the estate of the surviving spouse, the beneficiary of the QTIP. On the Federal Estate Tax Return this QTIP is not elected for marital deduction because together with Trust C it is equal to the Federal tax free amount. On the Massachusetts Estate Tax Return the QTIP is elected for the marital deduction, so no tax is due to Massachusetts. Thus, the whole Federal tax free amount is set aside, but no estate tax is due to Massachusetts.
- Next, if there is any remaining GST exemption, the Trustees allocate it to Trust B. If the remaining GST exemption is equal to or greater than the amount in Trust B, then only Exempt Trust B is created. If the remaining GST exemption is less than the amount in Trust B, then Exempt Trust B is created, which is equal to the remaining GST exemption amount, and Non-exempt Trust B is created, which is equal to the amount of Trust B that exceeds the remaining GST exemption amount.
- The Trustees then allocate all of the rest of the trust property that has not been allocated to Trust C and B, to Trust A. Trust A provides that the surviving spouse can control this amount so it is a marital deduction trust. As a result, there is no estate tax payable to Massachusetts or to the Federal government. This entire amount will be taxable, however, in the estate of the surviving spouse.
- If there is any remaining GST exemption after allocating to Trust C and B, it is allocated to Trust A. If the remaining GST exemption is equal to or greater than the amount in Trust A, then only Exempt Trust A is created. If the remaining GST exemption is less than the amount in Trust A, then Exempt Trust A is created, which is equal to the remaining GST exemption amount, and Non-exempt Trust A is created, which is equal to the amount of Trust A that exceeds the remaining GST exemption amount.
EXAMPLE: Assume that the Trust of the first spouse to die holds $3,200,000.00 of various assets. Assume that this spouse has made no gifts during his or her lifetime, which use any of his or her GST exemption or tax free credits. Also, assume that the first spouse dies in the year 2004 when the Massachusetts tax free amount is equal to $850,000.00 and the Federal tax free amount is equal to $1,500,000.00. Assume that the GST exemption is $1,500,000.00.
- Trust C is funded with $850,000.00.
- $850,000.00 of the GST exemption is allocated to Trust C, thereby creating Exempt Trust C. There is an available balance of GST exemption equal to $650,000.00.
- Trust B is funded with $650,000.00. (Trust C and Trust B together equal $1,500,000.00, the Federal tax free amount.)
- $650,000.00, the remaining GST exemption, is allocated to Trust B. Thus Exempt Trust B is created equal to $650,000.00.
- Trust A is funded with all of the remaining trust property or $1,700,000.00. So Trust A, $1,700,000.00, plus Trust B, $650,000.00, plus Trust C, $850,000.00, equals the full value in the trust or $3,200,000.00.
- Because all of the GST exemption was used in Trust C and Trust B, only Non-exempt Trust A is created.
COMPARISON OF FEDERAL AND MASSACHUSETTS ESTATE TAX EXEMPT AMOUNTS
|
For decedents dying in... |
Amount you can shelter from Massachusetts estate tax... |
Amount you can shelter from Federal estate tax... |
|
2003 |
$700,000 |
$1,000,000 |
|
2004 |
$850,000 |
$1,500,000 |
|
2005 |
$950,000 |
$1,500,000 |
|
2006 |
$1,000,000 |
$2,000,000 |
|
2007 |
$1,000,000 |
$2,000,000 |
|
2008 |
$1,000,000 |
$2,000,000 |
|
2009 |
$1,000,000 |
$3,500,000 |
|
2010 |
$1,000,000 |
Unlimited |
|
2011 & later |
$1,000,000 |
$1,000,000 |
