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Self Creating of Tax-Saving Trusts

Not only large estates face difficult tax issues, when the estate planning is done. Often federal and state laws need to be taken into consideration as well. That makes the whole drafting process more complex.

In addition the contractual freedo
m is somewhat restricted as soon as the IRS becomes involved. There are administrative rulings to be followed. This could for example mean, that the declaration of trust has to be drafted in a special terminology in order to fulfill certain tax advantage requirements for the IRS. If a living trust is drafted slightly different form those requirements you might lose the desired tax advantage.
An experienced trust attorney knows the administrative rulings and he is also capable of drafting a declaration of trust accordingly. Therefore the subsequent discussion of the different tax law implications can only provide an brief overlook on that matter. However the following information may eventually provide a good assessment tool whether tax is an issue to be taken care of or rather not.

Federal Estate Tax

The estate tax is a federal tax that is due when somebody dies and his or hers property is given to the heirs. It consists of an accounting of everything you own or have certain interests in at the date of death. It makes no difference whether such property is transferred via a will or according to the state laws of intestacy. A corresponding tax is the gift tax. The gift tax prevents avoidance of the estate tax through giving away estate just before one dies.

But there are important personal exemptions. The most important one is that there is never an estate tax as long as you leave your estate to a spouse (so called maritial deduction). All other persons profit of the current personal tax exemption. Simplified it can be stated that (for the year 2009) property with a value of $ 3.5 million can be left to other persons without paying estate taxes.

However the personal tax exemption is subject to change. First there will be no estate tax in 2010. In 2011 the personal tax exemption will be risen to 1 million dollars unless Congress extends the 2010 repeal. But that seems to be unlikely. Further reference to the current status of the federal estate tax can be obtained from the IRS (,,id=98968,00.html).

Optimizing your Estate Planning

Revocable living trusts generally do not protect assets within from the federal estate tax. As long as the grantor lives the property is treated as his very own. Upon his death the very same applies. Therefore the beneficiaries of the trust would be subject to federal estate taxes. Nevertheless the beneficiaries profit from the aforementioned tax exemptions. Therefore no estate tax is due as long as the assets, that the grantor leaves behind, do not exceed the tax exemption amount (e.g. $ 3.5 million for 2009).

Certain trust structures allow to combine the individual tax exemption of a couple in order to save estate taxes when the second spouse dies. Such trusts are known as A-B Trust and will be discussed below. Besides, your local estate planning law firm, for example Rinne Legal in San Francisco, Oakland, Fairfield, Walnut Creek and Sacramento will know the current law and optimize your estate planning accordingly.



Californian Estate Tax

Since January 1, 2005 there is no state imposed estate tax in California any more. It has been phased out in connection with federal estate tax law changes Therefore in our days a living trust in California only has to consider the federal estate tax as described above.




Tax saving trusts

Some trust are specifically designed to boost tax savings. The most common kind is the so called AB Trust (sometimes “bypass trust”, “Exemption trust”, “family trust” or “credit shelter trust”). AB Trusts are prevalent even as their tax saving effect applies to married couples only. Those trusts have an two-sided focus. They still avoid costly probate and can additionally provide significant estate tax savings on large estates.


Working Principle of a Tax Saving Trust

An AB Trust uses the personal estate tax exemption of each spouse to maximize tax savings on the combined estate for the heirs of the couple (in most cases their children). The construction utilizes an ordinary shared living trust for both spouses and two additional trusts for each spouse, Trust A and Trust B. If one of the spouses dies, all his designated property of the shared trust goes into a new Trust A, which becomes irrevocable and gives the surviving spouse a lifelong interest in the trust assets. No trust assets are transferred upon the death of the first spouse to the other spouse. They remain in the now irrevocable Trust A. The designated property of the surviving spouse goes into Trust B, which stays revocable. The children of the couple are usually nominated as second beneficiary of those two trust. Therefore they receive the trust assets of Trust A and Trust B (as long as the surviving spouse has not changed Trust B) according to the terms of the trusts.

In terms of estate tax the first transfer from the shared trust to Trust A is taxable, because  the marital deduction does not apply here. However there is still the personal threshold that reduces or nullifies estate taxes. When the children finally become beneficiaries of Trust A there is no more estate tax to pay. Estate Tax is then applied on the assets of Trust B (the trust of the surviving spouse). However now the personal estate tax threshold of the second spouse reduces or nullifies the Estate Tax of this transaction.

The Effect of a Tax Saving AB Trust

As a result the personal tax exemption amount of both spouses can be used for passing property to the children, thus the tax exemption amount of both spouses is combined. In contrary if the ownership of the first spouse’s property was transferred to the surviving spouse first and again transferred to the children upon the second spouse’s death, the tax exemption amount could only be used once. Given the tax exemption threshold would be $ 3.5 million (like in 2009) this construction allows couples to pass up to $ 7 million in property free of estate tax.

The tax saving effect has to be considered as soon as you and your spouse own property that is worth more than $ 3.5 million. However it is not always easy to determine the exact value of your property. Therefore when drafting a tax saving living trust construction, not only the complexity of the law has to be taken into consideration but also, accounting skills are required in order to do a proper evaluation of your estate assets. But there is no need to become desperate. The lawyers of Rinne Legal in San Francisco are looking forward to consult you and to provide the necessary estate planning assistance.


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