by Matthew M. Shafae and Justin M. Kennedy, Attorneys
Litherland, Kennedy & Associates, APC, Attorneys at Law
A lot of estate planning hypothetical situations involve the spouse dying, and the survivor getting hitched with some nefarious predator who is only after the survivor’s wealth. All of our attention is paid toward preserving the estate and protecting the kids. But what about a second marriage that actually benefits the kids, and helps preserve the estate? We recently had precisely that scenario in our office.
A married couple—let’s call them Bill and Sue—had a long, loving marriage. They raised children together, and they both worked hard, and amassed quite a sizable estate. In fact, they had done so well that their estate was pushing up against the estate tax exemption amount. Bill and Sue visited our office and developed a comprehensive estate plan that included an A/B trust. Bill and Sue wanted to make sure that their estate plan shielded their estates from the estate tax. (When Bill and Sue came to see us, portability did not exist yet, and the exemption amount was far lower than it is now).
Their fortunes took a turn for the worst when Sue was diagnosed with terminal cancer. Sue put up a strong-willed battle with the disease, but she passed away shortly after the diagnosis.
Bill came back to our office in order to administer his living trust into the A/B trusts. We helped Bill to allocate the assets between his A-trust and Sue’s B-trust. We also instructed Bill as to how he needed to manage the trusts moving forward. Since Bill had the A/B trust structure in his estate plan, Sue’s full estate tax exemption amount was preserved, and no estate tax was due upon Sue’s death.
Bill carried on with his life. His investments did very well. He even found love a second time—a very lovely woman named Lisa, whom Bill married. However, Bill also had the unfortunate problem of having so much wealth that he now had a taxable estate. Bill came in to see us again in order to discuss his options moving forward.
During the meeting with Bill and Lisa, Lisa emphatically explained to us that she did not want any part of Bill’s estate. It was all to go to Bill’s children. Bill insisted that he wanted to take care of Lisa for as long as she was alive, if he were to predecease her, and whatever was left would go to his children.
Here is Bill and Lisa’s financial situation. Lisa’s estate is valued at $3 million. Bill’s A-trust has grown to $7 million and the B-trust has grown to $7 million. (Remember that Sue’s estate is in the B-trust). Assuming Bill and Lisa both died in 2016, with a $5.45 million estate tax exemption, their estate tax calculation would be as follows:
- Lisa: $3 million is less than $5.45 million, so no estate tax due and $2.45 million of her estate tax exemption would not be utilized;
- Bill’s A-trust: $7 million – $5.45 million = $1.55 million x 40% = $620,000 estate tax due
- Sue’s B-trust: No estate tax due
Let us start with why the B-trust will not have an estate tax. The terms of the B-trust became irrevocable upon Sue’s death. That means that even if Bill wanted to change the terms of the B-trust to take care of Lisa, he could not implement the change. The B-trust provides that upon Bill’s death, the assets in the B-trust will pass to Bill and Sue’s children. The B-trust utilized Sue’s estate tax exemption upon her death. This allows the assets held within the B-trust to grow estate tax free during Bill’s life.
We needed to focus on the A-trust and figure out how to shield the excess over the $5.45 million estate tax exemption. We decided that the best way to help both Bill and Lisa was to incorporate Lisa into Bill’s A-trust. Lisa insisted that she did not want any of Bill’s estate; but what if she were to benefit from using some of his property, and in return she would contribute her unused estate tax exemption amount? She is, after all, his spouse.
We informed Lisa that if she allowed us to design estate plans for her and Bill that we could allow Bill to leave assets for her benefit (which is what Bill wanted) and doing so could save Bill’s children $620,000 in estate taxes by utilizing Lisa’s unused estate tax exemption. After the explanation, Lisa agreed to the approach.
We amended Bill’s A-trust so that when Bill dies, the A trust splits into two more trusts—a Family Trust that can receive assets with values totaling Bill’s estate tax exemption ($5.45 million) and a Marital QTIP Trust to catch the extra $1.55 million. Utilizing the unlimited marital deduction, upon Bill’s death, no estate tax would be due. The Family Trust preserves Bill’s estate tax exemption and can grow estate tax free during Lisa’s life, then pass to Bill and Sue’s children upon Lisa’s death. The Marital Trust was set up so that the income is payable to Lisa but she cannot use the principal. Both the Family Trust and the Martial Trust will become irrevocable upon Bill’s death, meaning that Lisa cannot change the terms of those Trusts. Even though Lisa cannot change the terms of the Marital Trust and cannot use the principal of the Marital Trust, upon Lisa’s death, the Marital Trust assets will be included in Lisa’s estate for estate tax calculations. As the $1.55 million plus Lisa’s $3 million estate is only $4.55 million, she will have no estate tax upon her death, and Bill’s children will inherit the Family Trust and Martial Trust assets with no estate tax due.
In the event that Lisa dies first, we would use portability to port Lisa’s unused exemption amount over to Bill. It would result in the same amount of savings to Bill’s estate. Just to cross our t’s and dot our i’s, we even decided to draft a post-nuptial agreement that would require that Bill’s estate indemnify Lisa’s estate in the event that this strategy would result in Lisa’s estate owing any estate tax.
Bill and Lisa both left our office satisfied. We were able to save Bill and his children from an enormous estate tax bill. Lisa was able to help Bill and his children by contributing her unused estate tax exemption amount, and she also derives some benefit from the Marital Trust while she’s alive.