With proper planning, a married couple can combine their two exemptions to protect double the amount of assets from estate taxes than a single person can protect. Saving on estate taxes helps your family preserve more assets for the next generation.
A disclaimer trust plan allows a married couple to leave all assets outright to the surviving spouse, but at the same time, it gives the spouse the option to minimize estate taxes. Essentially, it creates a safety net when a couple is not certain whether their combined net worth will exceed a single person’s estate tax exemption.
What is the current estate tax exemption level? A well-considered plan evaluates not only the federal estate tax exemption, but the exemptions of all states where the couple lives or owns property. As of January 1, 2021, the federal estate tax exemption increased to $11.7 million on January 1, 2021. Therefore, many couples do not have to worry about federal estate taxes under the existing laws (this could soon change). However, many states have much lower estate tax exemptions. Currently, 17 states and the District of Columbia impose an estate or inheritance tax, all with varying exemption levels. For example, Massachusetts has a $1 million exemption. Connecticut has $7.1 million exemption (as of January 1, 2021). Exemption levels may change in the future due to scheduled increases, cost of living increases, or changes in tax laws.
A disclaimer trust plan is commonly used for a married couple who currently have estate tax concerns but expects that to change in the future. Changes might happen because of a scheduled increase in the estate tax exemption. A change could also happen because the couple expects their asset level to decrease because of retirement spending. Some couples expect a change because they plan to move to another state with a higher estate tax exemption or no estate tax at all. An expected increase in assets from the sale of a business or success with investments may also prompt a couple to change from a simple Will to a disclaimer trust plan.
How does a disclaimer trust plan work? Each spouse leaves assets outright to the surviving spouse, with a contingent distribution to a Disclaimer Trust if the surviving spouse disclaims the inheritance. A “disclaimer” is a renunciation of a bequest. This disclaimer option gives the surviving spouse the opportunity to consult with an estate tax planner and determine whether tax planning is beneficial at that time. If tax planning is not deemed necessary at the time, then the surviving spouse takes the inheritance free of trust. If it is deemed necessary, the surviving spouse signs a document disclaiming certain assets into the Disclaimer Trust. Any disclaimed assets including appreciation in the value of those assets will not be subject to estate tax upon the surviving spouse’s death.
The Disclaimer Trust still gives the surviving spouse a great deal of control over the disclaimed assets. The surviving spouse is the beneficiary of the Disclaimer Trust. Typically, the surviving spouse is also the Trustee of the Disclaimer Trust. The trust can be structured so all the income of the Trust goes to the surviving spouse in at least quarterly installments. Upon the surviving spouse’s request, the Trustee must also pay the surviving spouse so much of the principal of the trust as the Trustee deems appropriate for the health, support and maintenance in accustomed manner of living of the surviving spouse.
To create the Disclaimer Trust, you must exercise your right to disclaim some or all the property from your spouse’s taxable estate within 9 months of your spouse’s death. You cannot take dividends or other benefits from investments that you will disclaim. To exercise this right, you must transfer the disclaimed property to the Disclaimer Trust. Therefore, it is vital to consult with an estate planning attorney soon after the death of the first spouse to die.
February 2021, Issue #30
Mark Pancrazio and Jack Reardon wrote the articles in this edition. No taxpayer can avoid tax penalties based on the advice given in this newsletter. This information is for general purposes only and does not constitute legal advice. For specific questions related to your situation, you should consult a qualified estate planning attorney.
