Until December 31, the lifetime gift tax exclusion is $5,120,000 per person. Unless Congress acts, this amount will drop to $1,000,000 on January 1, 2013. It is usually best to use a tax exemption as soon as possible – use it or lose it.
The opportunity, good now through the December 31, is to gift assets out of your estate and forever exempt the assets and all future appreciation from estate tax.
When we explain this to our clients with medium to large estates, they understand the value and urgency of gifting now, but many of them need the assets to live on. What good is it to give your children your assets when you still need your assets?
Enter the Lifetime Bypass Trust, also known as the spousal lifetime access trust. A lifetime bypass trust is an irrevocable trust that names your spouse as trustee and your spouse and children as beneficiaries. The assets you gift to the trust, and all future appreciation, will be exempt from estate tax. Until December 31, you can gift up to $5,120,000 to the trust, although many of our clients gift less.
This is the “have your cake and eat it too trust.” The trust assets will be exempt from estate tax when you die, when your spouse dies, and when your children die. In addition, you will retain indirect control and use of the assets because your spouse is the trustee and beneficiary. And if your spouse sets up a similar trust for you, you would have direct control and access to that trust’s assets as trustee and beneficiary, and those assets would also be exempt from estate tax.
Another way to look at it. You gift assets to a trust for your spouse, and your spouse gifts assets to a trust for you. You each control and benefit from each other’s trust, and the assets in each trust will be exempt from estate tax. What a deal!
Just like the A/B trust. You may be familiar with the basic estate tax concept of the A/B trust. When the first spouse dies, a bypass trust (B trust) is funded with the deceased spouse’s share of the estate. By using the deceased spouse’s estate tax exclusion, the assets in the bypass trust are exempt from estate tax. The surviving spouse is typically the trustee and the primary beneficiary. This gives the surviving spouse control and use of the bypass trust assets, yet the assets remain exempt from estate tax.
The lifetime exemption trust uses the same principle as the bypass trust, but instead of creating and funding it at death, it is created and funded now (before December 31) using some or all of each spouse’s lifetime gift exclusion.
Be careful. If each spouse creates a trust for the other, the trusts must be drafted to avoid the reciprocal trust doctrine. If the IRS finds the trusts identical, it will disregard them and pull the assets back into the donor’s estate. To avoid this, we make the trusts different. For example: the trusts could be funded with different assets, the husband could be given a right to income while the wife is given the right to income and principal, the wife could be given a power to name additional beneficiaries and the husband not given that power, or each trust could have different successor trustees or remainder beneficiaries. There are a number of ways the reciprocal trust doctrine can be circumvented based on your unique situation.
Additional benefits. The assets in the lifetime protection trusts would be significantly protected from lawsuits and divorce claims. So in addition to reducing your estate tax liability, you would be gaining significant asset protection.
Deadline looms. The lifetime bypass trust is a terrific tool to reduce or eliminate estate tax. But it must be created and funded before December 31, 2012.
Keep in mind it typically takes about three weeks to establish and fund a lifetime bypass trust. If this strategy appeals to you, you must act now, as time is running out.