Example of Misguided Use of Revocable Living Trust —
$435,000 in Unnecessary, Avoidable Federal Estate Tax
in a $2 Million Estate … An Almost 22% Tax Bite
- Married couple with children.
- The couple had a net worth of $2 million, all of which was community property; neither spouse had separate property.
- The couple created a Revocable Living Trust (the “Family Trust”) and transferred all of their assets to it.
- The Family Trust provides that all the property passed in trust:
- To the survivor of them upon the death of the first of them to die (the “deceased spouse”), and
- To their children upon the death of the surviving spouse.
- The first of them to die died in 2002.
- The surviving spouse died later that year.
| Husband: $1 million community half
|| Wife: $1 million community half
| First death:
|| Deceased spouse’s $1 million passed in trust to surviving spouse.
Surviving spouse now had $2 million of separate property (less any taxes, etc.).
| Second death:
|| Surviving spouse’s $2 million passed in trust to children.
Children now shared $2 million of separate property (less any taxes, etc.).
Success !!! Both spouses avoided probate — all of their property passed “outside of probate” through their use of a Revocable Living Trust.
“Estate Tax” Results:
At the deceased spouse’s death, the deceased spouse’s estate was required:
- To file a Federal Estate Tax Return (Form 706), but
- Not to pay any federal estate tax, as the deceased spouse’s $1 million was exempt from federal estate tax for two independent reasons:
- The $1 million Applicable Exclusion Amount (for Decedents dying in 2002 & 2003, the first $1 million passes estate tax free), and
- The Unlimited Marital Deduction (generally, all property passing to a surviving spouse passes estate tax free).
Success !!! The deceased spouse avoided both probate and estate tax.
At the surviving spouse’s death, the deceased spouse’s estate was required:
- Not only to file a Federal Estate Tax Return (Form 706), but
- Also to pay a federal estate tax, effectively on the amount in excess of the first $1 million (which passes estate tax free, due to the $1 million Applicable Exclusion Amount).
While he/she did avoid probate, the deceased spouse owed $435,000 in federal estate tax, reducing the children’s assets from $2 million to $1,565,000 — an almost 22% reduction.
|This entire $435,000 payment of federal estate tax was avoidable !!!
It was required because the couple used a revocable living trust
providing for the surviving spouse to receive all of the deceased spouse’s assets.
What might have been some of this couple’s “mistaken beliefs” that cost their children $435,000?
- Mistaken Belief #1: I can avoid paying estate taxes by avoiding probate.
- Mistaken Belief #2: I can avoid paying estate taxes by using a Revocable Living Trust.
- Mistaken Belief #3: Estate taxes apply only to those people who use a Will.
- Mistaken Belief #4: Estate taxes apply only to probate estates.
- Mistaken Belief #5: Both my spouse and I can avoid paying estate tax by giving each other our property.
|Ultimate Mistaken Belief:
(a state property law issue)
has something to do with
“Avoiding Estate Taxes”
(a federal tax law issue)