Minimizing Taxes

The unified tax credit allows each spouse to transfer up to the exemption amount to his children (or anyone else) free of any federal estate taxes. In its simplest form, a properly drawn revocable trust takes advantage of this benefit by providing for the creation of two separate trusts on the death of the first spouse. These two trusts are referred to as the A trust and the B trust. In a large estate, the B trust will be funded with the exemption amount and the balance will go into the A trust. From the A trust, the surviving spouse will have the right to all income for life plus a power to use any portion of the principal that he or she so desires. The B trust will generally provide that the surviving spouse is entitled to all income during his or her life plus the right to use principal for health, education, maintenance, and support. Any amount left in the A trust, in excess of the exemption amount, at the death of the surviving spouse will be taxable in his or her estate for estate tax purposes. However, since the surviving spouse is given only limited rights over the B trust, the amount in the B trust will not be taxable in the survivor’s estate upon his or her death. The effect of these provisions is that the spouses’ combined exemption amount (ultimately $2 million) can be passed from husband and wife to their beneficiaries without being subject to estate taxes.