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Estate and Gift Tax FAQ... Page 2
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How an AB Trust Works: An Example |
Ellen and Jack
have been married for nearly 50 years. They have one grown son, Robert, who is 39. Ellen
and Jack create an AB trust and transfer all their major items of property to it. They
name each other as life beneficiaries, and Robert as the final beneficiary.
Ellen dies first. The trust automatically splits into two parts. Trust A, which is
irrevocable, contains Ellen's share of the property. Trust B is Jack's trust, and it stays
revocable as long as he is alive.
The property in Trust A legally belongs to Robert, but with one very important condition:
his father, Jack, is entitled to use the property, and collect any income it generates,
for the rest of his life. When Jack dies, the property will go to Robert free and clear.
Now let's take a look at the tax savings:
Ellen's half of the trust property is worth $500,000 when she dies.
At Ellen's death, in 2000
| Taxable estate |
$500,000 |
| Estate tax |
$0 (because $675,000 can pass free of tax in
2000) |
At Jack's death, in 2004
| Taxable estate |
$500,000 |
| Estate tax |
$0 |
If Ellen had left all her property to Jack outright, his estate would have been worth
$1 million, $150,000 of which would have been taxed. |
Another way to save on estate taxes is to use what's called a "QTIP" trust. It
enables a surviving spouse to postpone estate taxes that would otherwise be due when the
first spouse dies. And there are many different types of charitable trusts, which involve
making a sizable gift to a tax-exempt charity. Some of them provide both income tax and
estate tax advantages.
4. Can't I just give all my property away before I die and avoid estate tax?
No. The government long anticipated this one. If you give away more than $10,000 per year
to any one person or non-charitable institution, you are assessed federal "gift
tax," which applies at the same rate as the estate tax.
Making gifts of less than $10,000, however, can yield substantial estate tax savings. If
you give away $10,000 for four years, you've removed $40,000 from your taxable estate. And
each member of a couple has a separate $10,000 exclusion. So a couple can give $20,000 a
year to a child free of gift tax. If you have a few children, or other people you want to
make gifts to (such as your sons- or daughters-in-law), you can use this method to
significantly reduce the size of your taxable estate over a few years. (The $10,000 amount
is now indexed for inflation, and will increase in $1,000 increments in years to come.)
Consider a couple with combined assets worth $1
million and three children. Each year they give each child $20,000 tax free, for a total
of $60,000 per year. In seven years, the couple has given away $420,000 and has reduced
their estate to $580,000, below the federal estate tax threshold.
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