Estate Planning to Minimize Taxes

In general, all estates are subject to estate tax. However, there are certain ways to avoid paying estate taxes.

One way is to use the unlimited marital deduction. The government exempts transfers between a husband and wife from estate and gift taxes. This means that in most cases, whatever you leave to your spouse will not be taxed.

In addition to the unlimited marital deduction, the federal government gives everyone a "unified credit". The credit exempts the first $1 million (in 2002 and 2003) of your estate from federal estate taxes. You can use your unified credit during your lifetime to reduce or eliminate gift taxes; otherwise, it will be applied to reduce estate taxes.

Unfortunately, those who have an estate valued over the applicable exemption amount and who rely completely on the unlimited marital deduction may not benefit from their unified credit as much. Using the marital deduction at the first death merely postpones estate taxes to the death of the surviving spouse. Then, when the surviving spouse passes away, the estate tax burden may be unnecessarily large.

Popular Planning Strategies to Reduce Estate Taxes

There are strategies you can use that may save you a substantial amount in estate taxes. One of the most widely used is known as the A-B trust. This strategy can enable you and your spouse to pass on up to $2 million (in 2002 and 2003) in assets - free of federal estate taxes.

A-B Trust Gives Both Spouses Unified Credit

By using an A-B trust, you will ensure that both spouses take advantage of the unified credit - once at the death of the first spouse, and then again at the death of the second spouse.

An A-B trust can be set up by establishing a living trust with an A-B provision. Upon the death of the first spouse, two separate trusts are created. The assets of the surviving spouse are transferred to the A trust, and an amount up to the exemption amount of the deceased spouse’s assets is transferred to the B trust. This then creates two taxable trusts, each of which is entitled to use the exemption.

The B trust is subject to estate taxes. However, because of the unified credit, no taxes will be owed. The surviving spouse maintains control over the assets of the A trust and receives income from the B trust. Then, at the death of the second spouse, only the A trust is subject to estate taxes because the B trust was taxed at the first death. After the death of the surviving spouse, the B trust can continue for the benefit of the grantors’ family, often the children. The trust assets can be divided into separate equal trusts for the benefit of the grantors’ children who will receive net income, and then at some specified age they will receive the principal.

There are many considerations involved with A-B trusts, and you’ll need the help of competent legal counsel. However, the A-B trust can be an effective way to reduce estate taxes and preserve family assets.