An exempt, or exemption, trust holds assets for a surviving spouse and other beneficiaries, usually a couple's children. Married couples generally create an exemption trust to avoid or minimize federal estate taxes that the IRS would otherwise assess when the last surviving spouse dies. When properly drafted, an exemption trust can provide significant estate-tax savings.
To take advantage of federal estate-tax laws, an exemption trust, also commonly known as a bypass trust, because it permits trust assets to bypass federal taxation, must satisfy several legal requirements. It must be irrevocable, which means that neither the trustor, the person who funds the trust, nor the person who administers the trust, known as the trustee, can cancel the trust. They also cannot change the beneficiaries or amend the trust in any other way. All of an exemption trust's assets must be held in the name of the trust.
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An exemption trust holds assets in a specific manner, which allows a surviving spouse to benefit from the trust's assets without taking ownership of them. A crucial element of an exemption trust is the amount of its funding. Federal tax law gives each U.S. citizen a personal federal estate-tax exemption. For a couple to take full advantage of each spouse's personal estate-tax exemption, funds placed in an exemption trust should not exceed the federal estate-tax exemption. The personal estate-tax exemption for an individual who dies in 2011 or 2012 is $5 million. Congress may change the amount of this exemption in the future.
How It Works
When one spouse dies, marital assets usually transfer to the surviving spouse, either by the terms of a will or a separate trust. Under federal law, all assets of a deceased spouse's estate that pass to his surviving spouse are exempt from federal estate tax. The assets placed in the couple's exemption trust remain in the trust when the first spouse dies. They are not part of the deceased spouse's estate. When the second spouse dies, the IRS will tax her estate only if its value exceeds her personal federal estate-tax exemption. The assets in the exemption trust are also not included in this spouse's estate. When the second spouse dies, the trust's assets transfer to the beneficiaries, or remain in the trust, depending on the trust's terms.
Because the exemption trust's assets are not included in the estate of either spouse, they are exempt from federal estate tax if their total value does not exceed the amount of the federal estate-tax exemption in the year the last-surviving spouse dies. For couples with large estates, an exemption trust preserves the exemption of the first spouse who dies. It avoids having all of a deceased spouse's assets transferred to the surviving spouse, which risks causing the value of that spouse's estate to exceed the amount of the personal federal estate-tax exemption.
An exemption trust provides benefits beyond its tax advantages. It enables both spouses to make estate-planning decisions, rather than leaving them up to the surviving spouse. An exemption trust also assures that assets go to children or other beneficiaries, avoiding potential conflicts if the surviving spouse remarries, or wastefully reduces the estate.
- "The Living Trust Advisor: Everything You Need to Know About Your Living Trust";Jeffrey L. Condon; 2011
- "The Trustee's Legal Companion"; Liza Hanks, et al.; 2010
- SmartMoney; Estate Taxes -- What Will You Owe?; May 2011
- "The American Bar Association Guide to Wills &amp; Estates"; American Bar Association; 2009
- IRS: Estate Tax
- Thrasher Buschmann &amp; Voelkel, P.C.: Funding the Family Exemption Trust; Dennis L. Voekel