In order to understand the value of a qualified domestic trust, you have to know some facts about the federal estate tax. This levy can have a serious impact on your legacy if you are faced with exposure, because it carries a draconian top rate of 40 percent. Fortunately, most people do not have to pay the tax because there is a relatively high credit or exclusion.
The federal estate tax exclusion is the amount that can be transferred before the tax would be applicable. In 2011, a $5 million exclusion was established via the enactment of a piece of tax legislation. Though there were subsequent tax laws enacted, the amount of the estate tax exclusion remained constant, but there were adjustments added to account for inflation.
After a series of inflation adjustments, in 2017, the exclusion was $5.49 million, but things were about to change in a big way. New tax laws were put into place, and the estate tax was affected. There is a great deal of relief, because the exclusion skyrocketed to $11.18 million. An inflation adjustment was added by the IRS in 2019, so we now have an $11.4 million estate tax exclusion.
This exclusion is allotted to each individual taxpayer. As a result, if you are married, your spouse would have an exclusion, and you would have your own exclusion. Using this year’s figure, a married couple would have a total exclusion of $22.8 million.
Going back down memory lane again, until 2011, your estate tax exclusion died with you. Before that year, a surviving spouse would not be able to use the exclusion that was allotted to his or her deceased spouse. This did not seem fair to many people, and their logic makes sense.
To provide an example, let’s say that you and your spouse are both professionals, and you have enjoyed very successful careers. Your earnings are similar, and you have both inherited about the same amount of money from your parents. Over the years, you have been able to accumulate a very significant store of wealth as a couple.
For the purposes of our example, we will say that you predecease your spouse. Most of your property is community property, and you leave your separate property to your spouse. The survivor will be in possession of wealth that was accumulate two people. Why should there be just one estate tax exclusion to utilize?
Legislators ultimately saw the logic in this argument. In 2011, the estate tax was made portable between spouses. As a result, a surviving spouse can use two estate tax exclusions.
Unlimited Marital Deduction
The estate tax is applicable on transfers to anyone, regardless of the relationship that you have with the person, with one exception. There is a federal estate tax unlimited marital deduction. This allows you to leave any amount of property to your spouse free of the estate tax.
However, there is one caveat to the above statement. If you are married to a citizen of another country, you cannot use the unlimited marital deduction. It is only available to citizens of the United States.
Qualified Domestic Trusts
Now that we have set the stage appropriately, we can explain the purpose of a qualified domestic trust. If you are married to someone that is not a citizen of this country, you would not be able to use the unlimited marital deduction as we have stated. As a response, you could convey assets into a qualified domestic trust.
When you do this, these resources would not be part of your estate immediately after your passing. In the trust declaration, you would name a trustee to administer the trust, and your spouse would be the first beneficiary. The trustee could distribute assets that are earned by the trust’s principal to your surviving spouse, and the estate tax would not be a factor. However, the distributions would be looked upon as taxable income by the IRS and the state tax authorities.
You could give the trustee the discretion to distribute some of the principal to your surviving spouse, but these distributions would be subject to the estate tax. This being stated, it is possible to petition the IRS to grant a hardship exception.
After your spouse passes away, secondary beneficiaries that you name in the trust declaration would assume ownership of the assets that remain in the trust. The estate tax would be applicable on the transfer, but there would be just one round taxation instead of two.
Attend a Free Estate Planning Seminar!
We are holding a number of seminars in the near future, and we urge you to attend the session that fits into your schedule. There is no admission charge, and you can visit our seminar page to see the schedule and obtain registration information.