A Living Trust has no effect on local taxes. It won't change the valuation of your home nor alter your homestead exemption in any way. Neither is there any effect on your income taxes. In fact, while both spouses are alive, no federal income tax return is filed for your Living Trust.

Your income is reported on your standard IRS 1040 form just as you have been reporting it for years. Uncle Sam says that you are the primary beneficiary of a revocable trust and entitled to every cent the trust makes while you are alive. The government wants you to report that income as your personal income just as if no trust existed. Your income taxes will come out to very same amount - trust or no trust.

Questions? How to contact Gordon Mead Bennett immediately!

Removing the mystery from Estate Taxes

We have already discussed the capital gains tax problems of giving assets to your children, jointly or wholly, before death. It is, however, in the land of federal estate taxes where the Living Trust really shines.

There is a great deal of confusion concerning estate taxes. Estate taxes have nothing to do with the cost of probate nor capital gains taxes. They are three different thieves, each trying to steal your money.

Federal estate taxes are assessed on the total net value of the assets you transfer to your heirs when you die. The possible existence of these estate taxes is present regardless of the technique in which you title your assets (sole ownership, joint ownership, corporation or trust).

For almost two decades each person was allowed a $600,000 exemption on the total inheritances the person passed to his/her heirs. A heavy tax of 37 percent kicked in on any excess over $600,000 and graduated up to 55 percent when the excess hit $3-million.

In other words, a husband and wife each had a $600,000 exemption and, by using their individual exemptions wisely, could pass a total of up to $1.2 million to their children without any estate taxes.

The exemption was increased to $625,000 per person on January 1, 1998, increased again to $650,000 on January 1, 1999 and went to $675,000 on January 1, 2000.

The exemption was scheduled to continue rising almost every year until it reached $1-million per person ($2-million for a married couple) in the year 2006. However, Washington May Madness, 2001 put an end to all of this and substituted a crazy quilt of tax cuts that come in and out of focus like a dance hall queen in the eyes of drunken sailor.

The federal estate tax exemption now increases according to the following schedule:

January 1, 2002     $1,000,000 per person
January 1, 2004     $1,500,000 per person
January 1, 2006     $2,000,000 per person
January 1, 2009     $3,500,000 per person

Also, the maximum tax charged on the sliding scale excess over the amount of the exemption makes its way downward from the present 55 percent to 45 percent over the same eight-year period.

On the surface all of this appears to be good news until one looks ahead 52 more weeks to January 1, 2011. Congress passed this new tax bill under "budget rules" which requires an expiration or "sunset" date of 2010 when this temporary law must be repealed. It is sort of like a test period to see how a new law will work. Unless congress acts to make these tax cuts permanent (I cannot believe it won’t), the maximum tax on the excess returns to 55 percent and the exemption may fall back to the 2001 level of $675,000 per person!

Much is still unclear because of the possibility of changes in the capital gains tax structure scheduled for the same year (2010) that may make for some tough sledding for estate taxes. Also, the United States Constitution mandates five congressional elections and at least one and possibly two administration changes through the year 2010. This will create a horde of new candidates pulling and pandering in ways that we at this time cannot imagine.

What has happened is that the big bucks contributors who keep the legislators in office with huge donations have been rewarded with a huge windfall. Also, lots of profitable estate planning work has been manufactured for the legislator’s fellow attorneys back home. Consequently, if you, the run-of-the-mill taxpayer, have plans of dying, do so before midnight, December 31, 2010 or your estate may well return to low man-on-the-totem-pole status like a hangover come New Years Day Morning, 2011.

Questions? How to contact Gordon Mead Bennett immediately!

Joint ownership: the perfect way to throw
away a $2-million exemption!

For years nearly every married couple has managed to squander one of its two available estate tax exemptions by holding assets in joint or co-ownership (both names on the titles and deeds of the assets).

The Internal Revenue Service looks upon joint ownership as separate and unrelated estates. As an example, let say that John and Mary Smith have a total estate of $2.6-million that they hold in joint ownership. Uncle Sam, however, says that John has a $1,300,000 estate and Mary has a $1,300,000 estate. And what a whale of a difference this makes. If John dies, his available $2-million exemption must be completely used (no carry over allowed) to pass his half of the estate to his wife, just as if he were passing the assets to his kids or any other heir.

Now, with John dead, the entire $2.6-million estate is in the sole ownership of Mary. Joint ownership is terminated and, most important, one of the couple's $2-million estate tax exemptions has been used up.

When Mary dies, she will have only her own $2-million exemption left to shelter her now sole-owned $2.6-million estate from estate taxes. There will be a $600,000 excess on which Mary's estate will have to pay $288,000 in federal estate taxes; money that could have easily gone to John and Mary's children had the two exemptions been used wisely.

A much more intelligent use of the exemptions by John and Mary would have been to employ what is known as an A-B Living Trust.

Questions? How to contact Gordon Mead Bennett immediately!

The tax-saving A-B Living Trust

Up until now we have been discussing what is known as a "common" Living Trust. When used by a married couple, each spouse is a co-grantor (maker) of a common trust. When one spouse dies, the survivor becomes the sole grantor of the trust in much the same way that joint ownership turns into sole ownership when one spouse dies. The survivor gains full control and has the right to change or amend any part of the (common) trust in any way he/she chooses - but in so doing loses one of the couple's two $2-million estate tax exemptions.

By adding several special paragraphs to the trust contract at the time it is drawn, a husband and wife can give each other permission to split the trust evenly into two sub-trusts at the death of the first spouse to die - one for each spouse (in John and Mary's case, approximately $1,300,000 is placed in each sub-trust).

The survivor's trust is known as Trust A while the decedent's trust is known as Trust B (pretty easy to see where it got the name of an A-B Living Trust, huh?).

The $2-million exemption of the first spouse to die is used to shelter Trust B. The survivor's $2-million exemption is put on hold and reserved to shelter Trust A when the survivor also dies a few years later. The couple can now take full advantage of both of their exemptions and by current 2007 standards pass up to $2-million to their heirs completely free of Federal Estate Taxes; $2-million from one spouse and $2-million from the other.

The increase in the exemption between now and 2010 will do the following for married couples holding their assets in an A-B Living Trust:

Jan. 1, 2002    $2.000,000 total exemption
Jan. 1, 2004    $3,000,000 total exemption
Jan. 1, 2006    $4,000,000 total exemption
Jan. 1, 2009    $7,000,000 total exemption
Jan. 1, 2011    To be determined later!

This ability of an A-B Living Trust to double the amount of your available estate tax exemption (especially at these new rates) should all by itself be reason enough to abandon joint ownership of assets immediately and get into a Living Trust.

However, there are other major advantages to an A-B Trust:

1. The surviving spouse can spend both principal and income from his/her own Trust A in any manner; no restriction.

2. Trust B becomes irrevocable at the death of the first spouse to die and cannot be changed at the whim of the survivor (perhaps through the influence of a new spouse) as can happen with either a will or a common trust. Thus, the rights of the deceased spouse are protected even in death.

3. The surviving spouse is permitted to spend all income earned by Trust B such as interest and dividends, plus the greater of $5,000 or 5 percent of principal in Trust B every year in any manner, no matter how foolishly.

4. In addition to the yearly $5,000 or 5 percent of principal that can be spent in any manner from Trust B, the surviving spouse is also permitted to spend unlimited sums of principal from Trust B for education, health care and to maintain the lifestyle enjoyed during the marriage. In most marriages that would mean that the surviving spouse could also use the principal from Trust B for such lifestyle-maintaining expenses as buying a new car, paying the rent, remodeling the kitchen, putting a new roof on the house, taking a conventional vacation and other like-expenditures. However, the IRS would frown on using funds from Trust B to speculate on a new growth stock or to lease a condo in Cancun.

5. The A-B Trust is also ideal for couples in their second marriages since each spouse, using a special memorandum, can place assets in the trust for the mutual enjoyment and use of both, but upon death must come out of the trust and be distributed to the heirs of the first marriage.

Those married couples who project their estates to be in excess of $7-million in 2009 should strongly consider a Living Trust combined with a Family Limited Partnership.

Bypass Trusts - Buyer beware!

One of the cruelest maneuvers of attorneys is to suggest a bypass trust arrangement which will supposedly allow the client to take advantage of a married couple’s two estate tax exemptions. Unlike an A-B Living Trust (a single trust executed while both grantors are alive which splits into two sub trusts at the death of the first spouse to die), the bypass trust is nothing more than a testamentary trust in diguise designed to work to the attorney's advantage rather than the client's. A trust contract is written but nothing else is done; assets remain in the private ownership of the grantors. The bypass trust is set up in your Last Will and Testament which means that your estate must endure the full trappings and expense of Probate Court before the trust can become operative.

As the long probate procedure finally winds down (a year or two after death) it is the probate judge that orders the assets placed in a trust. The successor trustee is then free to distribute the assets from the trust to beneficiaries. This distribution usually takes place within a few hours which means that the whole process is nothing other than a total waste of time and money. The exception of course is to the attorney who has managed to manipulate the estate into Probate Court where he can skim 10 percent off the top - and also charge you for a useless bypass trust.

At the first mention of a bypass trust in your attorney’s office, the red lights should start flashing in your mind. There is a speeding train coming down the track that for the sake of your loved ones you surely want to avoid!

Go to Lesson 8