 Personal Finance PowerPoint Presentation Exemption Trust Prepare to get financially fit by practicing personal finance Support Accounting Instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category, further broken out by course Each course then organized in a logical, reasonable fashion making it much more easy to find what you need than can be done on a YouTube page We also include added resources such as Excel practice problems PDF files and more like QuickBooks backup files when applicable So once again click the link below for a free month membership to our website and all the content on it Most of this information comes from Investopedia Exemption Trust You can find online, take a look at the references Resources continue your research from there This is by Julia Kagan, updated August 11, 2022 In prior presentations we've been taking a look at a state planning then focusing in on particular tools that could be used in it this time that being the Exemption Trust So the first question is what is an Exemption Trust? An Exemption Trust is a trust designed to drastically reduce or eliminate federal estate taxes for a married couple's estate So in prior presentations we talked about basically the timeline through the estate planning process and an overview Let's imagine that in this circumstance, so at the time before death then we want to plan out what's going to happen at the point of death so that we can allocate our assets in accordance with our wishes One of that allocation wishes probably being to reduce the amount taken by the government and then we'd also like to make it as easy as possible on our loved ones at that point in time to manage the process So the first tool we think about is a will typically but the will has some limitations because it still basically has to go through probate often times so you might be able to make that process a little bit easier by setting up some type of trust So that's one thing to basically consider Then we also have the added complication if we're married because if you're married then you're basically one legal entity for some purposes including like tax purposes for example and so on but also in some ways you could still be considered kind of two individuals So are you considered one legal entity or two legal entities? If you're one legal entity you would think that as one person dies then the assets would naturally be going to the other person or would be managed by the other person in the legal entity and then as the second person dies that legal entity has now passed away and then you would have the situation that would be similar to one person dying if they weren't in kind of a married situation but that could change a little bit from state to state such as if you're in community property states or not so you want to have some understanding of the kind of legal entity of the marriage and then the next thing that you have to consider is the fact that you have the taxes that could be applied and this usually applies for people that's income is above a certain threshold then the government's going to look at their assets or their estate at the point of death and try to assign an estate tax which is basically applied to a balance sheet as opposed to an income tax so it's a little bit unusual for us to typically think about because usually we'd say well it's already been taxed it was taxed when we earned it on the income side no it's taxed on the estate so then we of course want to limit the estate taxes and one of the issues with the estate tax is if it's similar to the like if you had one person that died that wasn't married then there's kind of like an exemption that you get so if you're below the exemption it's kind of like a standard deduction for an income tax and if your income is below that threshold then you might not be subject to the estate taxes but what if you're married and one person then gives all of their assets to the other person or by the time the second individual dies I think that you would have an exemption equivalent to the two individuals to write a married exemption is what you would kind of call it on an income tax side meaning the standard deduction is usually twice as much for a married couple as a single couple so on the estate taxes it gets a little bit complicated to make sure that you're maximizing your exemptions for the two individuals to reduce the estate taxes as much as taxes those being the death taxes, taxes at the point of death so that's the general idea okay so now we've got this trust that could be set up one just simply to make it easier for probate purposes but then two you've got the trust concept that could help you to reduce the amount of estate taxes primarily by making sure you're taking advantage of the exemptions and then of course there's a bunch of other strategies that could be taken when you get into more complex estate planning for higher income individuals okay so this type of a state plan is established as a irrevocable trust so it's irrevocable as opposed to revocable we talked about that in the past that will hold the assets of the first member of the couple to die an exemption trust does not pass the assets along to the surviving spouse okay so what's kind of like the rationale of this obviously when the second spouse dies if they have the rights to all of the assets basically then they would be subject to that being their estate and that might be over the threshold or more likely to be over the threshold for estate taxes and have the tax on it if you could say well if one person died then those assets go into a trust then although the surviving we're trying to set up a trust that's separate whereas so it's a separate legal entity so it's kind of like a corporation in a similar way as a corporation but then it's not in the name of the other spouse so that when the second spouse dies hopefully then that second spouse isn't going to have to have an estate that includes those first assets which could again lower the amount of estate taxes would generally be the basic idea so as its name suggests an irrevocable trust cannot be changed or invalidated without the permission of the trust beneficiary so a primary benefit of an irrevocable trust is that it removes assets from the grantor's taxable estate thereby diminishing the estate's tax liability assets in a revocable trust could include one or more of the following cash, investments, a house, life insurance policies a business, precious gems, fine arts or antiques for example any kind of valuables in general how an exemption trust works an exemption trust is a popular estate planning tool for affluent married couples mainly more well off wealthy people the primary goal of an exemption trust which is also known as a bypass trust or credit shelter trust is to mitigate a couple's federal estate tax liability so you're trying to minimize the tax liability of course with an exemption trust the surviving spouse does not inherit the assets of the first member of the couple to pass away so the first member passes away you would think in general that the second one would basically be in charge of all the assets they would be in their name that's what we're trying to avoid so we can get the exemption so we have to set up a separate legal entity would be the general concept and that's my interpretation of it this makes its provisions very different than that of many wills so generally you would think it would be more complex than the standard will the surviving spouse is quote bypassed and the deceased assets are held in a trust so remember that a trust kind of like a corporation is kind of like a separate legal entity which can now own things note that one of the characteristics of a corporation is that it's it's it doesn't it can theoretically not die right it can continue on and the ownership can basically be passed on similar kind of concept with the trust so when surviving spouse dies the assets are distributed to the trust beneficiaries typically their children if they had any because the surviving spouse did not inherit the assets directly the beneficiaries are not held responsible for any estate taxes when they receive the trust assets after the surviving spouse dies another benefit of an exemption trust is that before the surviving spouse passes away they still retain several access rights to the trust assets during the remainder of their lifetime so notice this is kind of like the in-between line that you're always trying to walk oftentimes when you're doing this type of estate planning because you'll note that they had to set up that kind of irrevocable trust the idea being that the person doesn't have the capacity just to kind of reverse what they did but at the same time still give some leeway to the individual to have access over the money that's in the trust because you're trying to get the best of both worlds here meaning you're trying to say I no longer have access to these assets in some way that's why it might not be included in the in the estate for example but at the same time we want to set up the trust so it's doing what that individual wants them to do so that's kind of the tightrope that ends up being walked and a lot of these kind of estate planning situations when they're setting up some kind of trust in this fashion so for example a surviving spouse and this is just one example this is one very common kind of example a common tool that's used but you can imagine other ways that you can have similar tools and have similar goals in place for estate planning using tools like trust so for example a surviving spouse can tap into both the trust's income and its principal to pay for certain medical and educational expenses 2017 federal tax law benefits exemption trusts the tax law passed by congress in late 2017 raised the exemption limit for estate taxes in fact it doubled the cash value amount that couples can transfer without being subject to estate taxes obviously as we're doing our estate planning we have to realize that there's a lot of uncertainty with regards to the estate tax law it can change drastically depending on the political environment and that uncertainty needs to be taken into place when we're doing long term strategic planning with regards to estates so the prior exemption amount was just shy of 5.5 million dollars per person as a result of the tax reform the exemption was increased for an unmarried person increased to 11.4 million for tax years 2018 through 2025 so for most people you're probably saying well that's still quite high for the average individual but just a couple things to note note that the estate tax as well as kind of the income tax when it was really first put into place was thought that it was only going to be applied to very well off individuals which these days you would think like the billionaires would be the equivalents of what they're thinking about when it was first put into place because those are the people that benefited most from kind of like the infrastructure and so on and so forth and then these things tend to expand also note that the primary tax we have is the income tax you get taxed when you earn the income and now if you tax the balance sheet you tax the estate your taxing basically the balance sheet that's kind of like a double taxation so it has kind of expanded to more people than you would think and that gets a little bit scary as it basically continues to expand it's also going to look like a much smaller number 11.4 even that number which is a lot different than the 5.5 that's a lot shy of like the billionaires at this point in time and it's probably going to look a lot smaller if inflation continues to eat into it at a higher pace because then the purchasing power will go down so in any case therefore if the gross value of the exemption trust grantors estate is less than 11.4 million when that individual dies no estate taxes have to be paid so that's the general idea but notice that they don't have a different exemption really for a married then an individual so this you can think of this number as being similar to the standard deduction for income taxes but you would think that they would have twice that much for a married couple right that's what they do with the income taxes but that's not quite how it works so now the question is well if you're married couple how do you get advantage of the fact that you should get twice that much you would think why don't they just put that in the well then you're going to have to do this funny trust thing or something to make sure that if you're if you're subject to the estate tax that you're trying to get the full amount of the exemption if you can so and even if the total value of the estate exceeds 11.4 million limit only the amount in gross excess of the exemption level is taxable in other words if an estate is worth 100 $100,000 more than the exemption limit only the 100,000 is taxed rather than the 11.4 million so again you can kind of think of that as kind of like the standard deduction right you're going to get for the income taxes you're going to be taxed at the amount that's above that threshold is the general idea so example of exemption trust exemption trust often use an AB trust system in which two trusts one belonging to each spouse are funded roughly with the same amount and number of assets suppose Prahya and Krishnan I probably said those completely wrong have created an exemption trust using the AB trust system when Prahya dies her assets are passed on to trust B and the excess beyond exemption limit in this case roughly 11.4 million is funded into trust A to avoid federal estate taxes because now one person died they're married instead of them instead of the money just going to the other individual you want to maximize the amount of the exemption that they would get at that at the point of death right so that you could fully grasp and that's so you're going to so you're going to give it not to the other individual you're going to give it to the trust and you're going to take the exemption so that you're under the threshold which is at 11.4 at this point in time okay so the fund and its income are available to Krishnan during his lifetime so when he dies 11.4 million is defined by the federal exemption limit from trust A is passed on tax-free to his beneficiaries utilizing Krishnan's exemption limit the remaining amount is taxed however funds from trust B are passed on tax-free to the final beneficiaries