Planning and the Living Trust

A Revocable Living trust does not in and of itself provide any estate tax savings. At present all property passing to a surviving spouse passes free of estate tax (the marital deduction). Property which does not qualify for the marital deduction can be sheltered by the wealth exemption. There is no estate tax on estates which do not qualify for the marital deduction and which have a net value of $10 million (as adjusted annually for inflation) or less. In addition, a deceased spouse’s wealth exemption amount can pass to the surviving spouse thus allowing the survivor a wealth exemption of $10 million (as adjusted) (this concept is known as “portability”). As a result, the surviving spouse can receive the deceased spouse’s entire estate tax free without limitation and can pass more than $10 million (as adjusted), at the survivor’s death without tax.

When one spouse wishes to provide, on the death of the surviving spouse, for beneficiaries different than those of the surviving spouse the terms of the trust can provide for the establishment of additional trusts on the death of the first spouse to die (the “deceased spouse”). In which case, some or all of the deceased spouse’s interest in community and separate property is retained in an irrevocable and unamendable trust for the benefit of the surviving spouse with any property remaining in the trust on the survivor’s death passing to beneficiaries named by the
deceased spouse.. The surviving spouse’s interest in community and separate property is then retained in an revocable and amendable trust for the benefit of the surviving spouse with remainder beneficiaries named by the surviving spouse. Any property added to this Survivor’s Trust may be withdrawn by the surviving spouse at any time.

A situation could arise in the future where a married couple’s estate, while not presently large enough to result in an estate tax on the survivor’sdeath, could become large enough in the future to result in a tax. This could occur either
because the wealth exemption decreases in the future or because the value of the married couple’s estate may increase over time. Thus, the trust should contain a provision allowing thesurviving spouse to elect to refuse some or all of the deceased spouse’s estate. This isaccomplished by the surviving spouse “disclaiming” some or all of the deceased spouse’s interest in the community or separate property which would otherwise pass outright to the
survivor. A “Disclaimer Trust” is usually included in the trust instrument to allow the surviving spouse the opportunity of making this tax saving election.

For married couples having an estate valued in excess of twice the wealth exemption amount or for single persons having an estate valued in excess of the wealth exemption amount further planning should be considered.


Gifts are one of the principal ways of avoiding estate tax. Many sophisticated planning techniques are based upon gifts. Currently each person (a donor) may make an outright gift of up to the amount of the annual exclusion (currently $14,000 annually) to any number of individual, non-charitable recipients (donees). In addition, each person may pay annually for the benefit of any number of individuals any amounts of educational or medical expenses so long as they are paid directly to the entity providing services to the donee. All such gifts are known as
annual exclusion gifts.

With only a few exceptions gifts in trust for a donee do not qualify for the annual exclusion.

In addition, under current law, each donor has a lifetime total $5 million (adjusted annually for inflation) exemption from gift tax. However, the fair market value at the date of a gift made using the lifetime exclusion is reincluded
in the donor’s estate at death. Thus, gifts using the lifetime exclusion should be of property likely to appreciate in value or which is subject to a discounted valuation at the time of the gift. It is this difference between the value at the donor’s death and the gift tax value that isthe true tax free gift.

The cost basis of gifted property is the donor’s cost basis not the fair market value at the date of the gift.

Once a gift has been made it is gone forever. With few exceptions, the donor cannot retain any right to enjoy the gifted property.

Family Limited Partnership (FLP)

When in effect the estate tax is a tax on the fair market value of property transferred at death. Fair market value is defined as what a willing buyer would pay to a willing seller. Easy to saybut sometimes not so easy to determine.

The concept of discounting is the moving force behind FLPs. However, an FLP can also provide some liability protection. Because a limited partner has only limited control over his or her investment in a limited partnership the fair market value of a limited partnership interest is less than the proportionate value of the assets held in the limited partnership.

For example: Because of lack of marketability or lack of control a 10% limited partnership interest in a FLP holding an asset worth $100,000 would have a fair market value of something less than $10,000; perhaps its fair market value would be $7,500 or less. This enables the holder of limited partnership interests to discount their value when making a gift and allows for a discount when valuing the remaining limited partnership interests in the owners estate for estate tax purposes.

The use of a FLP is disfavored by the IRS and there are many limitations on its use. Time prohibits an in depth discussion here; however, a FLP works particularly well if there is a valuable family business or parcel of commercial real property (subject to property tax limitations).

Qualified Personal Residence Trust (QPRT)

A QPRT is a method whereby a donor (optimally with a life expectancy of at least 10 years) can make a gift of his or her residence at a discounted value and retain the right to remain in the residence for a set period of time. At the end of the term of the trust the donor can either move or rent the residence from the donee. If properly constructed these future rent payments can be tax-free transfers to the donee.

Irrevocable Life Insurance Trust (ILIT)

As the name implies ILITs are funded by insurance. Insurance owned by an ILIT is not subject to estate tax on the death of the insured and the proceeds are income tax free. Thus, the proceeds of an ILIT pass income tax and estate tax free on the death of the insured. Generally the beneficiary of an ILIT is given a limited power to withdraw contributions to the trust. In this way each annual contribution to pay premiums qualifies as an annual exclusion gift. However, the proceeds can be held in a further trust for the beneficiary.

The terms of an ILIT cannot require it to be used to pay estate taxes but the proceeds can be a source for loans by the beneficiary to an estate or trust to pay these taxes, or the proceeds can simply replace the funds used to pay taxes.

Grantor Retained Annuity Trust (GRAT)

A GRAT is a trust in which the donor can make a gift at a discount and still retain the right to receive income for life or a period of years. Whether or not such a gift makes economic sense depends on the age of the donor and the amount of the annuity payments. Each case must be analyzed individually.

Charitable Remainder Trust (CRT)

If you are at all interested in leaving a charitable legacy the CRT may be the way for you to retain income and at the same time make a charitable gift.

In this case the charitable gift is discounted by the right to retain a stream of income or an annuity payment during your lifetime. It works particularly well if you have an unencumbered commercial real property that has been fully depreciated, represents a low return on investment, and is a headache to manage. Selling the property and investing the proceeds in short term obligations or other securities could incur a capital gains tax.

By using the property to fund a CRT you allow the charity to sell the property tax-free and re-invest the full proceeds to fund the payments to you. The payments to you will be taxable income but this income will be sheltered a least in part by the charitable deduction you receive for your gift of the charitable remainder. The value of the asset given to the CRT can be replaced by an ILIT.

The CRT has also been recommended as a way to shelter from capital gains tax any equity thatyou may have in your home in excess of the exclusion ($500,000 for married couples and $250,000 for singles).

For example: H & W want to move to assisted living. They would like to sell their home and invest the proceeds in order to help to support themselves in assisted living. They don’t want to wait until one of them dies before moving to assisted living. The adjusted cost basis in their home is $250,000 and the home has no encumbrance. The net proceeds from the sale of their home would be $1,000,000. By giving a 25% interest in their home to a CRT they can retain the sheltered proceeds of $750,000 and receive a stream of income from the $250,000 undiminished
by tax.

The CRT may also provide a solution as a gift to a spendthrift beneficiary while reducing estate taxes.

Charitable Lead Trust (CLT)

The opposite of the CRT this trust provides income to the charity and at the end of the term distributes the balance remaining (at a decreased estate tax value) to a beneficiary designated by the donor.

Alaska, Delaware, or Nevada Trust

A self-settled (self-created) trust created under California law cannot exempt the trust assets from the creditors of a settlor (creator). However, under the laws of Alaska, Delaware and Nevada such a trust can exempt its assets from the claims of the settlor’s creditors.

Many legal experts question whether such a trust is effective against judgments obtained in a non-resident settlor’s place of domicile (where the judgment can be enforced by contempt proceedings).

Off-Shore Asset Protection Trust

This is a trust which is created and administered in a foreign jurisdiction which does not recognize within its jurisdiction (or makes it extremely difficult to recognize) U.S. court money judgements against the settlor. This type of protection has proven to be effective only if the debtor remains outside the jurisdiction of the U.S. court. If the debtor is physically within the jurisdiction of the U.S. court that court can enforce its judgments by contempt proceedings.

Dynasty Trust

The anticipated Generation-Skipping Transfer Tax (GSTT) is a distinct tax separate and apart from estate, gift and income taxes. Many of its exemptions are similar to the estate tax but their differences can be a trap for the unwary. The GSTT takes effect on the transfer of principal but is in addition to and not instead of gift and estate taxes. A person more than one generation below the donor is a “skip person”. Transfers to skip persons are a generation-skipping transfer subject to the GSTT. The GSTT is computed at a rate equal to the highest estate tax rate in effect at the transfer.

Each person has an annual exclusion from the tax equal to the gift tax annual exclusion and applicable to each and every donee; however, the application of the exemption may require filing a GSTT return even when no gift tax return is required to claim the gift tax annual exclusion.

Each person has a lifetime exclusion equal to the estate wealth exclusion in effect at the date ofthe transfer.

Space does not permit a further discussion of the complicated GSTT here; however, it must be considered anytime you wish to make a gift to a skip person, whether directly or by possible default.

The Dynasty Trust provides that successive generations enjoy distributions of income or principal from the trust using the donors GSTT exemption. Some copyrighted trusts such as the so called “Super Trust” purport to allow the beneficiaries to enjoy assets such as works of art, automobiles, and residences without effecting a “distribution.”

Most states have enacted the Rule Against Perpetuities. This rule puts a time limit on the length of time the principal of a trust can remain undistributed. Thus, in those jurisdictions (including California) the principal of the Dynasty Trust must eventually be distributed. However, some states, have abolished the Rule and as a result the Dynasty Trust could arguably continue as long as assets remain in the trust.