By Kathleen Fowler, Esq.
What is a Trust?
A trust is an entity that provides for the separation of legal ownership from beneficial ownership. We tend to merge these concepts, but trusts separate the two by giving the Trustee the legal title to the trust property and the beneficiaries the right to the benefits of that property.
How do Trusts reduce estate taxes?
The first way to reduce estate taxes is for a husband and wife to each create a Revocable Trust and transfer their assets equally to each Trust. When the first spouse dies, his or her Trust names the surviving spouse as the beneficiary. The Trustee has the legal ownership over those assets. As long as the deceased spouse's Trust shelters the amount that can pass estate tax free, there is no estate tax. When the surviving spouse dies, there is no estate tax on the amount that his or her Trust can shelter and on the amount in the predeceased spouse's sheltered trust. The result: the children receive assets from both parents free of estate tax. If this Trust arrangement was not used, the surviving spouse would own all of the couple's assets and the family would lose the estate tax exclusion allowed at the death of the first spouse.
The second way to reduce estate taxes is through gifts to an Irrevocable Trust. An Irrevocable Trust cannot be changed by the person who created it (the Settlor, Donor or Grantor). The Settlor makes gifts to this Trust. The transferred assets are no longer part of the Settlor's taxable estate. The exception: when an existing life insurance contract is transferred to an Irrevocable Trust, there is a three year period before the death benefit is removed from the Settlor's taxable estate.
What gifts escape the gift tax?
- Annual exclusion gifts equal to $13,000.00 per Settlor per beneficiary in 2009; and
- $1,000,000 lifetime gift exemption. With enough beneficiaries, you could give away your entire estate using the annual exclusion. The $1,000,000 lifetime exemption has a catch - all of these gifts are added back to your estate at death, which pushes your estate into a higher tax bracket, but the $1,000,000 exemption is given back as a tax credit. In certain instances, however, using this exemption makes sense.
What is a Dynasty Trust?
A Dynasty Trust is not only for the wealthy - it is simply a Trust that uses your Generation Skipping Tax Exemption (GST).
The Internal Revenue Code is designed to collect an estate tax in every generation. The GST tax is assessed when assets pass to an individual two or more generations below the transferor (e.g. grandparent to grandchild). The GST exemption allows up to a certain amount to pass estate and GST tax free to those individuals. Currently, the GST exemption equals the amount that can pass federally estate tax free ($3,500,000 in 2009).
A Dynasty Trust holds assets in trust for multiple generations. No estate taxes are paid during the term of the Trust because the Trust is using the Settlor's GST exemption. And once sheltered in the Dynasty Trust, the assets grow estate and GST tax free.
In addition, with the inclusion of simple language, anyone suing a beneficiary (e.g., a divorcing spouse, lawsuit plaintiff, creditor) cannot access the assets held in the Trust.
By creating a Dynasty Trust that uses your GST exemption, you will be giving your family more than the assets that you accumulated during your lifetime - you will be giving them added protection from estate taxes and creditors.
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