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The Flexible Estate Tax Planning Trust

Disclaimer trusts provide the ultimate estate tax planning flexibility.
"In this world, nothing is certain except death and taxes." - Benjamin Franklin

When it comes to estate taxes (otherwise referred to as death taxes), however, the subject is anything but certain.

The Estate Tax and its Inherent Uncertainty

The Federal estate tax is essentially a transfer tax on everything that we own when we die. Fortunately, we each have a credit (frequently referred to as the unified credit, the applicable exclusion amount and/or the exemption amount - all of which refer to the same thing) to offset this tax. The result is that Federal estate tax is only due if a person dies owning assets that have a total value in excess of the applicable credit amount in their year of death. In other words, if a hypothetical estate is worth $7 million, and the hypothetical credit is $6 million, the only the $1 million excess would be subject to tax at a rate of (wait for it....) 40%.

This is where the uncertainty kicks in. The amount of the credit is subject to constant change based on a host of political and economic factors. Take the current state of the law for instance. The credit is currently a whopping $12.06 million per person, leaving only a small percentage of estates subject to tax (because most people's total net worth is far below that amount). However, that amount is only temporary. In 2026, the credit is set to be lowered to $5 million per person, adjusted for inflation (so maybe $6 million or so). Moreover, the Biden administration had its sights set on lowering the credit amount much sooner, and possibly to as low as $3.5 million per person. Numbers like those start to raise legitimate concern for many more families, especially when you realize that the estate tax applies at a rate of 40%.

How Estate Planning with Trusts Can Help

One of the many reasons that we use trusts in estate planning for married couples is the ability to allocate assets following a person's death in such a way as to minimize or avoid estate taxes. A key technique involves shifting a deceased person's assets into an irrevocable trust, frequently referred to as a "bypass trust" (also referred to as an exemption trust or credit shelter trust) that uses the deceased spouse's credit before it expires (so that those assets are not taxable later when they pass to the children for instance) while keeping those same assets available to be used as needed by the surviving spouse for their support and maintenance during his or her lifetime.

The challenge in many instances however is that, because of the uncertain nature of the credit amount, it's difficult to predict whether or not a bypass trust will ultimately be needed. If the estate planning attorney drafts a trust in such a way that a deceased person's assets (or part of them) must be allocated to a bypass following their death, and it ultimately turned out not to be necessary (based on the size of the applicable credit relative to the size of the person's estate), then the attorney has created post-death administrative complexity and expense that was avoidable, and also put the assets allocated to that bypass trust at an income tax disadvantage when they're later transferred to the children or other beneficiaries following the surviving spouse's death due to the loss of step-up in basis on those assets.

Enter the Disclaimer Trust

For many married couples, a disclaimer trust structure creates the best of all worlds. Here's how it works:

  • At the death of the first spouse, all assets transfer to the surviving spouse outright, unless the surviving spouse chooses to "disclaim" (refuse to accept) the outright distribution of all or any portion of the deceased spouse's share of the assets.

  • Any assets the surviving spouse chooses to disclaim are transferred to a bypass trust, where the spouse is able to use all assets as needed during his or her lifetime for health, support and maintenance to maintain their same standard of living. As a bonus, the bypass trust assets are able to be protected from any of the surviving spouse's creditors and from liability for any lawsuits or other claims that may be field against the surviving spouse. At the death of the surviving spouse, the assets in the bypass trust transfer to the children or other beneficiaries estate tax free.

The beauty of the disclaimer trust is that it provides complete flexibility. Rather than trying to pigeonhole the estate into a mandatory plan of action based on uncertain factors (such as the applicable credit amount in the future, as well as the size of the estate), the disclaimer trust structure provides a "wait and see" approach that can be deployed later when all of the relevant factors are known. If it makes sense to do so, then the surviving spouse has 9 months from the date of death to be able to disclaim assets into the bypass trust. If it does not make sense to disclaim, then the spouse can keep things simple and accept the assets outright (by keeping them in the initial revocable trust that he or she established with the deceased spouse).

Now, for My Disclaimer :)

Although it's a great choice for for many estates, for others, particularly those where estate tax is very likely going to be a factor regardless of the size of the applicable credit, the disclaimer may not be the most prudent option. Therefore, it's always advisable to consult with a knowledgeable estate planning attorney and/or tax professional for the best advice for each individual situation.


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