Kathleen ReynoldsKeymasterNovember 7, 2022 at 9:22 pmPost count: 428
Credit Shelter (Bypass) Trust – The amount passing to the trust at the death of the estate owner is the unused applicable exclusion amount for estate tax purposes. The bequest to the trust is estate tax free because the estate owner’s unified credit covers the tax on the exclusion amount. Example: Assume estate owner has made $500,000 of taxable gifts during lifetime and dies in a year when the applicable exclusion amount for estate tax purposes is $2,000,000. The trust would then be funded to $1,500,000 (assuming no part of the $1,500,000 applicable exclusion amount remaining at death is used for other transfers at death that are subject to estate tax).
The trust will typically have two classes of beneficiaries. The income beneficiary will receive all income earned by the trust each year. The definition of income may be structured to include actual earned income and, if desired, all or a portion of trust appreciation. Typically, at the death of the income beneficiary (assume the surviving spouse), the trust principal will be paid to the remainder beneficiaries (children). Since the income beneficiary would have the use (trust income) but not the actual ownership of the trust principal, no portion of the trust principal (including appreciation after death of estate owner) should be included in the surviving spouse’s estate. Thus, the trust is referred to as a credit shelter trust because the trust principal is sheltered from estate tax at the demise of the estate owner and surviving spouse.
QTIP States – the following States can defer the amount of State estate/inheritance tax paid at the first death. These states are:
- Rhode Island
The QTIP is created based on the amount of exemption left at first death based on the state exemption. So, if the state exemption is 2 million, and there is $5 million total Federal remaining, then the QTIP is $3 million. It is called a QTIP because the tax is avoided at first death and becomes a liability at second death.
If the taxable estate is $5 million at first death. Assume Federal Exemption left of $5 million, and a state exemption of $2 million.
If the State does not allow a Qtip transfer at time of first death (to avoid State taxes at first death), then the State taxable estate would be $3 million. The Federal taxable estate would be $0 (assuming death in 2012, exemption of $5.12 million for Federal).
If the State has a Qtip election different than the Federal, then in the case above the State taxable estate at time of first death would be $0. ($2 million exemption, and the remaining $3 million is placed into the ‘State Qtip’) The State QTIP is then taxed at second death ONLY from the State side (it is not calculated in the Federal calculation).
First Estate: $3 Million
Exemption: $2 Million
QTIP Amount: $1 million (no taxes)
Second Estate: (Assume the second estate has $5.12 exemption) $10 million
Amount taxable for Federal: $4.8 million
Amount Taxable for State: 10 million – 2 million (state exemption) + $1 million (QTIP Amount)
The QTIP specifically moves the State inheritance/estate tax consequence from the first to the second estate.
The flowchart displaying the Credit Shelter Trust amount includes any State amount that has a QTIP election. We do not separate the State vs. Federal on the flowchart.
Analysis of Taxes at Death shows the details of the State specific amount at the first death. This amount is added into the equation when calculating the State inheritance/estate tax due at the second death
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