The amount of the estate which is exempt from tax under an AB Trust, is now $1,375,000, and by the year 2006 will reach $2,000,000. While the couple is married, all of the community property remains in one combined AB Trust. Upon the death of the first spouse, the survivor as the sole trustee, divides the estate in two subtrusts, designated A and B. As trustee of both subtrusts, the surviving spouse can purchase and sell assets in either subtrust at any time. However, no assets have to be sold in order to divide the estate into the subtrusts.

TRUST A

Trust A consists of the survivor's half of the property, and also the decedent's half in excess of $675,000. The surviving spouse has the right to all of the income and the assets. Moreover, the survivor can change the heirs or cancel the trust. If not canceled, upon the survivor's death, the trust is distributed to the survivor's heirs. Upon the survivor's death, the trust is tax exempt on the first $675,000 and the balance of the trust is subject to federal and estate taxes.

TRUST B

Trust B consists of the decedent's half share up to $675,000. The surviving spouse has the use of the income for normal living expenses, and the survivor can draw on the principal of the trust after exhausting Trust A. The survivor cannot change the heirs or cancel the trust, and upon the survivor's death, the trust is distributed to the decedent's heirs. Upon the survivor's death, the trust is completely tax-exempt even if with appreciation, it exceeds $675,000 at the time of distribution to the heirs.

AB TRUST EXAMPLE

Dick Smith and Jane Smith have a combined community property estate of $1,350,000, and establish an AB Living Trust.

Upon Dick's death, Jane will have all of the assets of the estate appraised and will meet with an accountant to divide the $1,350,000 estate into two sub-trusts, as follows:

Jane's Trust A will consist of her $675,000 one-half share of the community property.

Dick's Trust B will consist of his $675,000 one-half share of the community property.

Jane, with the assistance of her attorney, will have the assets retitled to reflect ownership of the assets in the various Trusts, and can make investments in either Trust as she pleases.

Each year, Jane will report the income from her own Trust A on her personal income tax returns, and John's Trust B income will be reported on separate fiduciary income tax returns.

No estate taxes will be payable by Jane at the time of Dick's death.

Upon Jane's death, the two sub-trusts will be distributed to the heirs.

There will be no estate tax on Jane's death, assuming her Trust A stays below her $675,000 exemption.

If Dick and Jane Smith had held their $1,350,000 estate in joint tenancy, there would have been no estate tax on Dick's death.

However, Jane would have inherited the entire estate as surviving joint tenant, and upon her later passing, the total estate taxes would have been $235,000, computed as follows:

ABC TRUST

If a married couple has a combined community property estate of over $1,350,000, an ABC Trust is generally created, for additional assurance that the estate will remain intact for later distribution to the heirs. An ABC Trust functions in all respects as an AB Trust, with the exception that, upon the death of the deceased spouse, the survivor divides the estate into three sub-trusts, as follows:

Trust A

Trust A consists of the survivor's half of the community property. The surviving spouse has the right to all of the income and assets. The survivor can change the heirs or cancel the Trust; otherwise, upon the survivor's death, the Trust is distributed to the survivor's heirs. Upon the survivor's death, the Trust is tax exempt on the first $675,000, and the balance of the Trust is subject to estate taxes, when the survivor dies.

Trust B

Trust B consists of the decedent's half up to $675,000. The surviving spouse has the use of the income for normal living expenses, and the survivor can draw on the principal of the Trust, but only after having first exhausted Trust A and also Trust C. The survivor cannot change the heirs or cancel the Trust, and upon the survivor's death, the Trust is distributed to the decedent's heirs. Upon the survivor's death, the Trust is completely tax exempt, even if, with appreciation, it exceeds $675,000 at the time of distribution to the heirs.⁵

Trust C

Trust C consists of the decedent's half over $675,000. The surviving spouse has all of the income for support, and can draw on the principal of the Trust after having first exhausted Trust A. The survivor cannot change the heirs or change the Trust, and upon the survivor's death, the Trust is distributed to the decedent's heirs. Upon the survivor's death, the Trust is part of the survivor's taxable estate to be subject to estate tax if the survivor's estate exceeds $675,000.

ABC Trust Example:

John Smith and Mary Smith have a combined community property estate of $2,000,000, and establish an ABC Living Trust. Upon John's death, Mary will have all of the assets of the estate appraised and will divide the $2,000,000 estate into three sub-trusts, as follows: Mary's Trust A will consist of her $1,000,000 one-half share of the community property. John's Trust B will consist of $675,000 of his $1,000,000 one-half share of the community property. John's Trust C will consist of $325,000 of his $1,000,000 one-half share of the community property. Mary, with the assistance of her attorney, will have the assets retitled to reflect ownership of the assets in the various Trusts, and can make any investments. Each year, Mary will report the income from her own Trust A on her personal income tax returns, and John's Trust B and C income will be reported on fiduciary income tax returns. No estate taxes will be payable by Mary at the time of John's death. Upon Mary's death, the three sub-trusts will be distributed to the heirs. There will be a $320,000 estate tax on Mary's death, based upon the then current value of Trusts A and C, less her $675,000 exemption, computed as follows:

If John and Mary Smith had held their $2,000,000 estate in joint tenancy, there would have been no estate tax on John's death because of the marital deduction. However, Mary would have inherited the entire estate as surviving joint tenant, and upon her later passing, the total estate taxes would have been $588,000, computed as follows:

 John and Mary's heirs will have saved estate taxes of $268,000 with the Living Trust, computed as follows:

POUR-OVER WILL

Cash or stock in the decedent's individual name which are not included in the Living Trust, can be added without probate to the Living Trust, through a pourover will if the amount is less than $60,000. If it is more than $60,000, then those items must be probated.

You should not conclude from these technical illustrations and examples showing how taxes are minimized that this is the most important element of estate planning. Although its technical and can save lots of tax dollars, it’s secondary to properly providing for disposal of your assets now or when you die. Who gets what and how much? Who will take care of my affairs, my children, wife (or husband) and/or a third party? How will they manage my things? Recognize my immortality? Where will I be buried or cremated? What will happen if I can’t make decisions about myself or the last few years of my life? Talk to an lawyer, discuss and answer these questions, and then have the lawyer document your considerations. Do it now even if you can’t arrange everything. You can amend the documents later.

Second, let’s look at Powers of Attorney.

POWER OF ATTORNEY FOR PROPERTY MANAGEMENT

A Durable Power of Attorney for Property Management permits the decedent's agent to act in his or her behalf, often without the need for probate. However, there are a number of unknown risks and liabilities for the agent in acting under a Power of Attorney. Accordingly, these instruments should be used with caution.

DURABLE POWER OF ATTORNEY FOR HEALTH CARE

This instrument permits the maker of the instrument to designate an agent for health care decisions, including the withdrawal or removal of life support systems, in certain circumstances. The agent is usually the spouse or trusted friend or child. The document may be used only when the maker is competent.

Third, let’s look at Living Wills.

LIVING WILL

A Living Will is similar to a Durable Power of Attorney for Health Care, but it does not designate an agent. Rather, it is instructions directly to health care providers, giving them instructions on how to care for the maker in the event of incapacity, and instructing them under what circumstances it is appropriate to remove life support systems, usually in the event of an incurable and irreversible condition. But some people want to be kept alive at all cost and for as long as possible, which is their right, and their living will can so provide.

Life Insurance Policies will be addressed in the next version of this paper.

Notes:

¹ As of July 2000, there were two Congressional Bills pending which would greatly reduce or eliminate the federal estate tax over ten years.  The President stated he would veto an outright appeal, but some reduction in the present death tax rates is a possibility.  Nevertheless, death tax planning remains important especially in larger estates.

²  As of December 31, 2000.

³  As of December 31, 1998.

⁴  This example is slightly less because the exemption is now $675,000 and will increase to $1,000,000 for each spouse by the year 2006.

⁵  This trust is often designated the "By-Pass" or "Credit" Trust.

⁶  This example is slightly less because the exemption is now $675,000 and will increase to $1,000,000 for each spouse by the year 2006.