During 2012, every U.S. citizen has a $5,120,000 estate tax exemption. This means that the first $5,120,000 of a decedent’s assets transfer to the decedent’s heirs without paying any federal estate tax. However, the $5,120,000 exemption is only in effect through December 31, 2012, and will be reduced to $1,000,000 as of January 1, 2013, unless Congress extends the exemption. There are no California estate taxes.
Under the marital deduction rule, any property you leave or gift to your spouse passes to your surviving spouse tax free providing your surviving spouse is a U.S. citizen. If your spouse is not a U.S. citizen, then the personal estate tax exemption can be used to avoid or reduce estate taxes. Property you leave to your children which exceeds the estate tax exemption is taxable. If you are a married couple, you might want to think about establishing an AB or Credit Shelter Trust to reduce your federal estate taxes.
How The AB/Credit Shelter Trust Works?
For our example let’s assume the estate tax threshold goes back to $1,000,000. A married couple establishes a revocable trust with provisions that upon the death of the first spouse, the trust will be divided into two parts. Let’s say the value of the couple’s marital estate is $2,000,000. After the death of the first spouse, the trust is then divided into two trusts- Trust A and Trust B. Trust A holds the survivor’s share of the community property and the survivor’s separate property. Trust B holds the decedent’s assets for the benefit of the surviving spouse during the surviving spouse’s lifetime. If everything was community property each trust will hold $1,000,000. The surviving spouse is entitled to the income from the assets in Trust B during the surviving spouse’s lifetime. The surviving spouse also has control over how the assets in Trust B are invested. The assets in Trust B pass to the designated beneficiaries after the surviving spouse dies. Typically couples designate their children as beneficiaries. After the surviving spouse passes, the $1,000,000 in assets in Trust B passes to the children tax free. The $1,000,000 in assets in Trust A also passes directly to the children tax free. The children get to inherit $2,000,000 tax free, so that they get the full benefit of the $1,000,000/person exemption from estate tax.
It is recommended that you speak with a California estate attorney who can explain the benefits of establishing an AB trust and whether it is right for your financial situation. Please feel free to call our office at 858-792-5988 for a consultation.