By: Justin M. Kennedy, Attorney
Law Office of Roy W. Litherland
Prior to 2014, for married clients with estates valued at over one million dollar ($1,000,000), our office often recommended ABC Trusts. This trust structure was used to preserve the Deceased Spouse’s estate tax exemption. For much of that time, there was a one million dollar ($1,000,000) estate tax exemption. Utilizing the ABC Trust structure allowed you to double that, to be able to pass two million dollars ($2,000,000) free of the estate tax.
It worked like this, upon the first death, the Surviving Spouse’s share of the trust went into the A-Trust. The Deceased Spouse’s share of the trust, up to the estate tax exemption, went into the B-Trust. And if the Deceased Spouse’s share of the trust exceeded the estate tax exemption, the excess would spill over into the C-Trust (taking advantage of the unlimited marital deduction to pass this amount to the Surviving Spouse free of the estate tax). Upon the Surviving Spouse’s death, the B-Trust would pass free of the estate tax (even if the amount in the B-Trust had grown to exceed the estate tax exemption). The A-Trust and C-Trust (if used) would be added together and whatever exceeded the Surviving Spouse’s estate tax exemption would be subject to the estate tax.
When portability was added to the law we now had the ability to preserve the Deceased Spouse’s estate tax exemption without the need of the B-Trust. Clients could enjoy the ease of a trust structure that only formed the A-Trust upon the first death. In order to preserve the Deceased Spouse’s estate tax exemption, the Surviving Spouse needs to affirmatively elect portability by filing IRS Form 706. The 706 estate tax return informs the IRS that the Surviving Spouse is electing to keep the Deceased Spouse’s estate tax exemption.
For our married clients who still wanted to make sure that the Deceased Spouse’s share of the trust would be irrevocable upon their death, we shifted from ABC Trusts to Clayton Trusts. The Clayton Trust still possesses the ABC Trust structure, but where the ABC Trust requires that the Deceased Spouse’s share must go into the B-Trust and only allows the C-Trust to be used as a spill-over-trust, with the Clayton Trust, both the B-Trust and C-Trust are options.
As discussed previously, assets in the B-Trust grow free of the estate tax. Assets in the C-Trust will be included in the Surviving Spouse’s estate for estate tax purposes, but this provides for a step-up in basis (the elimination of capital gains for tax purposes) upon the Surviving Spouse’s death.
The current estate tax exemption is set at $5,000,000 and indexed for inflation ($5,490,000 in 2017). This means that married couples can pass up to $10,980,000 free of the estate tax. The vast majority of our clients who have implemented the Clayton Trust structure use the C-Trust in order to pass the assets to the beneficiaries free of capital gains taxes.
The B-Trust has one advantage that I have not yet addressed and that is the ability to preserve the Deceased Spouse’s Generation-Skipping Transfer Tax exemption. While portability allows for the assets to pass free of the estate tax, it does not preserve the Deceased Spouse’s Generation-Skipping Transfer Tax exemption, an exemption that applies when assets will be preserved for multiple generations. If the client wants the assets to continue to be held in the trust for the benefit of children, grandchildren, and great-grandchildren, then preserving the Generation-Skipping Transfer Tax exemption with the B-Trust may be the best strategy.
It is important to remember that with the Clayton Trust, the decision as to which Trust to use (the B-Trust or the C-Trust) is not made until after the first spouse dies. Upon the death of the first spouse, we recommend that the Surviving Spouse contact our office so that we can guide them through these important choices.