Revocable Living Trusts: Should Couples Use Joint or Separate Trusts? (Part II)

April 3, 2011
300px N12453669 33496777 98 Revocable Living Trusts: Should Couples Use Joint or Separate Trusts? (Part II)

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In Part I of this topic, we discussed that the decision to use joint or separate trusts is mainly based on the answers to these three questions:

  1. Under federal and/or state law, are you married to your partner – Yes or No?
  2. Do you live in a Community Property or Separate Property State?
  3. Will your anticipated estate potentially be subject to estate taxes – Yes, No, or Maybe?

Now, we conclude by assuming you and your partner are married and live in a separate property state.

Why to Disregard the 2010 Tax Relief Act

To review, the 2010 Tax Relief Act (discussed in much greater detail here) includes both a $5 million estate tax exemption for every individual and “portability” of this exemption between spouses. In theory, the combination of these two provisions would result in no estate tax for the vast majority of Americans.

To illustrate, if you die with $1 million in your estate, your representative can opt to apply the unused $4 million of your exemption to your surviving spouse’s $5 million exemption.  Then, your survivor’s estate would have a $9 million exemption.  In other words, a married couple’s first $10 million is exempt from estate tax.

Since more than 99% of us do not have that level of wealth, this would appear to be exciting news (especially if tax law floats your boat).  At first glance, it looks like we may never have to worry about estate taxes ever again!

But, alas, our glorious dream of a taxless-estate nirvana has not arrived just yet. Here’s why:

  • The $5 million exemption is only available until the end of 2012.  As of now, the exemption drops back to $1 million starting in 2013.
  • The portability option only lasts until the end of 2012.
  • Both spouses need to die between now and the end of 2012 for the $10 million benefit to apply.

The result is that, as Deborah Jacobs articulately pointed out on forbes.com, most estate planning professionals will ignore the $5 million exemption and portability until they become permanent.  Instead, we’ll conservatively apply the projected 2013 rules (a $1 million exemption & no portability) when making our recommendations.

Now that that is all cleared up, we can go back to the joint vs. separate living trust discussion using these assumptions.

You Anticipate Your Estate Will Not Be Taxed

If you are married and will jointly have less than $2 million in your estates after your deaths, a joint trust is recommended:

  • A joint trust is simpler and would enable you both to maintain control over the trust assets together.
  • The joint trust can still be drafted to protect your children from creditors, rogue spouses, and themselves, or at least provide the survivor with the flexibility to do so.

You Anticipate Your Estate Will Be Taxed

If you are married and will jointly end up with more than $10 million, separate trusts are preferable:

  • The survivor will be able to amend his or her own trust after the first death.  This is much more difficult, if not impossible, with a joint trust.  This is particularly relevant when one spouse has brought most of the assets into the marriage.
  • For example, if Spouse A has $10 million and Spouse B has $1 million, Spouse A will most likely want to control of as much of the combined $11 million as possible if Spouse B dies first.  Spouse A would lose much of this flexibility in a joint trust.

You Are Not Sure If Your Estate Will Be Taxed or Not

Finally, if you are married and your joint assets will be between $2 million and $10 million, no preference can be stated because of the uncertainty in the level of the estate tax exemption in the future.

Not knowing the exemption amount requires significant flexibility in your trust to help your trustee minimize taxes.  To accomplish this, most revocable trusts in this asset range, joint or separate, are drafted to segregate assets into a marital share (to qualify for the unlimited marital deduction) and a non-marital share (to qualify for the estate tax exemption).  Then, avoiding estate taxes becomes much easier if the trustee can determine the best split at the times of your deaths.

Using a joint trust in this range creates potential, yet avoidable, risks that do not exist with separate trusts.  For example, after the first death, the trustee of a joint trust must not apply the survivor’s interest in any joint trust assets to the non-marital share, or else the entire share may not qualify for the estate tax exemption.

Additionally, the following non-exhaustive list of factors should also be considered:

  • Your desire to keep your assets together or separate.
  • Your desire to protect trust assets from outsiders.
  • The stability of your marriage.
  • Whether there are children from a prior marriage.
  • Your state’s estate and inheritance tax rates.
  • The tax basis of your assets.
  • Whether you own any community property.
  • Whether you have already used some of your estate tax exemption.

As any of these concerns could tip the scales one way or the other, it is imperative that you consult with an estate planning professional to help you figure out your own best path.

Thank you for reading — as always, please comment below!

 Revocable Living Trusts: Should Couples Use Joint or Separate Trusts? (Part II)
 Revocable Living Trusts: Should Couples Use Joint or Separate Trusts? (Part II)

Scott

Scott R. Zucker, Esq. is the owner of The Zucker Law Firm PLLC, located just outside the Capital Beltway in Annandale, within five miles of the City of Fairfax, the county seat of beautiful Fairfax County, Virginia. The firm focuses mainly on estate planning services for Virginia, Maryland and Pennsylvania clientele, and seeks to do so in an affordable and approachable way. People interested in learning more can contact Scott by phone or email.

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7 Responses to Revocable Living Trusts: Should Couples Use Joint or Separate Trusts? (Part II)

  1. April 19, 2011 at 4:32 pm

    Question—With less than 2 million but more than 1 million in MD would you still use a joint trust where the estate tax starts at 1 million ?

    • Scott
      April 20, 2011 at 2:42 pm

      Terry–

      This is an excellent question.

      Recall that currently, estate planning attorneys conservatively apply the projected 2013 rules (a $1 million exemption & no portability) when making recommendations. As a result, the federal and Maryland estate tax exemption would be the same.

      As a result, a Maryland married couple will have the use of $2 million of Maryland’s estate tax exemption (i.e. $1 million used two times).

      Therefore, as in the federal case, if you project that your joint estate will exceed $1 million and not exceed $2 million by the time of the surviving spouse’s death, a joint trust should be adequate (as long as the plan properly provides for the optimal usage of marital deduction and credit shelter planning). However, be sure to look closely at the other factors listed as well, as these recommendations cannot and should not be made in a vacuum.

      I hope this helps.

      Take care,
      Scott

  2. Debra Prince
    April 27, 2011 at 5:13 pm

    A fiduciary prepaid collateral inheritances on a bypass trust in maryland, then needlessly liquidated the trust 4 years later, transferring all assets into the widow’s personal accounts. The trustee had never reported distributions of principal, so I and my sibs were paying taxes on the entire amount again! ($40,000.00 when the husband passed away and trust was funded; $45,000.00 8 years later when the spouse passed away.) Is there any way to reclaim these losses?
    Also, could you tell me if the home is taxed twice? The personal representative declared 50% value on the 1st estate (1998), but the whole value when the spoused died. We’re now paying taxes on a home valued at $800K that in fact was sold for a fraction of that, but the unethical executor. (also sold “not at arm’s length; yuppy castle constructed on the sight shortly after closing!”

    • Scott
      May 2, 2011 at 4:23 pm

      Ms. Prince–

      I am so sorry to hear about your troubles!

      Let me make clear that without all of the facts of the case, I am unable to state definitively what is going on here. What follows are merely suggestions of areas you should look into — please do not regard this as legal advice! Now, let’s go through your scenario.

      1) I am uncertain as to why the fiduciary paid the collateral inheritance on the bypass trust. If the first death occurred in 1998, then it occurred before Maryland decoupled from the Federal estate tax system, so any amounts in the bypass should have been estate tax free. If this is the case, I’m not sure why $40,000 was paid that year.

      2) It does not sound as if the fiduciary got your approval before liquidating the trust in 2002. Were you a named beneficiary of the trust? Were your siblings listed? Usually a trust is not liquidated without the consent of all present and future beneficiaries, but this would mainly depend on the wording in the trust and the amount that was left in the trust.

      4) Maryland is a common law property state, so if your parents owned property jointly at the time of your father’s death, then it’s true that the property was only entitled to a 50% step-up in basis at the time. Example: If they originally bought the house for $50,000 and it was worth $350,000 at the first death, his half would step up to $175,000, and hers half would remain at $25,000 for a total of $200,000. But if your mother remained in the home and did not sell it, no estate or capital gains tax would have been due at that time.

      5) At the second death, the property would have gotten a full step up to the property’s value on the date of your mother’s death.

      6) Were you and/or your siblings named as beneficiaries of the house? If so, why are you paying taxes on an $800,000 home if it was already sold? If you don’t own it, and it was sold for a fraction of the $800,000, then you wouldn’t owe property taxes, plus you would not owe capital gain taxes on the loss from the step-up value.

      7) Maryland has a three-year statute of limitations from the date a reasonable person would have discovered a fraud for a beneficiary to sue a fiduciary. As such, I would seek counsel to resolve these issues immediately!

      Best of luck!

      Scott

  3. Debra Prince
    April 27, 2011 at 5:14 pm

    re above: collateral inheritance taxes were $40K; estate tax 2007 was $45K

  4. February 23, 2012 at 10:46 pm

    where is part 1?

    • Scott
      February 23, 2012 at 11:47 pm

      Mr. Sargent–
      Here is a link to Part I. You can also find it linked in the first sentence of the post.

      Thank you so much for stopping by! Please let me know if you have any questions or comments.

      Take care,
      Scott

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