David De Jong and David Torchinsky publish article in MACPA's Statement magazine
Statement magazine, a publication of the Maryland Association of Certified Public Accountants, Inc.
Media Type: Publication
The 'gap trust': Ideal in Maryland for the mid-size estate
On Dec. 17, 2010, President Obama signed new estate tax legislation into law that included an increase in the federal estate tax exemption to $5 million for individuals who die in 2011 and 2012. Thus, after taking into consideration any lifetime taxable gifts, the estate of an unmarried individual who dies in 2011 or 2012 with a taxable estate of $5 million or below will not owe any federal estate tax.
In addition to the increase in the exemption, provisions were enacted to allow a surviving spouse to elect to receive any unused exemption from the first spouse to die and add this unused amount to the surviving spouse's own exemption, provided that the election is made on a timely filed federal estate tax return of the first spouse to die and the survivor dies in 2011 or 2012. This concept is called "portability."
At this time, we don't know whether or not portability will apply after 2012. Every practitioner must consider whether or not to file a federal estate tax return for a married individual who dies in 2011 or 2012, even if a return is not otherwise required; otherwise, portability will be lost. Portability of the earlier decedent spouse's exemption is lost in any event on the survivor's remarriage.
Despite the increase in the federal estate exemption and the enactment of portability, it still makes sense to create an estate plan with bypass language, especially for Maryland residents.
The Maryland estate tax exemption is still $1 million and no portability exists for Maryland estate tax purposes. For example, if husband and wife have combined assets of $2 million and the first spouse dies leaving everything to the surviving spouse, and then the second spouse dies with a $2 million estate, the Maryland estate tax would be $99,600. If husband and wife have divided their estates in half with the use of a bypass trust, no Maryland estate tax would be owed on the second death since Maryland estate tax on two $1 million estates is zero.
Suppose instead that the husband and wife have combined assets of $4 million and they divide their assets in half so each of them can utilize their Maryland estate tax exemptions. Upon the death of the first spouse, the husband's half is valued at $2 million. Thus the Maryland estate tax on the first death would be $99,600 only if the couple did not do proper planning. With proper estate planning, even though the first spouse to die has an estate in excess of the Maryland exemption, the Maryland estate tax on the first death could be zero through the use of a Maryland QTIP trust.
Here's how it works.
Upon the death of the first spouse, the traditional bypass trust could be established sheltering the first $1 million of assets. This is the amount that would be free from both federal and Maryland estate taxes. The surviving spouse and other family members (if desired) could receive discretionary distributions of income and principal from the bypass trust for health, education, support and maintenance with a broader standard if there is an independent trustee. The excess assets above $1 million would be held solely for the benefit of the surviving spouse in a special Maryland QTIP trust which is often called a "gap trust."
The gap is the difference between federal estate tax exemption and the Maryland estate exemption. Thus, while there would be flexibility regarding the first $1 million, the surviving spouse would be required to receive all of the income from the gap trust and would be the only individual permitted to receive principal.
By using the gap trust, no Maryland estate tax would be due on the death of the first spouse. Since the bypass trust, combined with the gap trust, is below the federal estate tax exemption of$5 million, both the bypass trust and the fop trust, including any capital appreciation on both, would not be included in the surviving spouse's taxable federal estate.
Any balance remaining in the gap trust at the death of the surviving spouse would be included only in the Maryland taxable estate of the surviving spouse. Assuming the federal estate exemption is $5 million and the Maryland estate exemption of $1 million, the gap trust could hold up to $4 million of the first deceased spouse's assets. For married individuals whose estates are more than $5 million, any excess above $5 million on the first spouse's estate could still be held in a traditional marital trust or go outright to the surviving spouse.
Other reasons exist for married individuals to continue utilizing traditional estate planning, such as protecting the beneficiaries of the first spouse to die, as well as creditor protection in the bypass, gap and traditional marital trusts. Thus, for now, traditional estate planning is here to stay.
In most mid-size Maryland estates, this involved drafting dispositive estate documents with disclaimer language allowing the surviving spouse with professional guidance to determine the optimum amounts to be placed in the bypass trust, the gap trust and the marital trust (or outright to the survivor). Timely disclaimers to effectuate the estate plan must be executed within nine months of the death of the first spouse; this period is not lengthened by filing an extension of the federal or Maryland estate tax return.
David S. De Jong and David B. Torchinsky practice law with the Rockville law firm of Stein Sperling Bennett De Jong, Driscoll PC. Mr. Torchinsky is current president of the American Association of Attorney-Certified Public Accountants. Mr. De Jong is a past president of that organization.
This issue of Statement is available online for MACPA members.
This artilce is reprinted with permission from MACPA.Attachments: The 'gap trust' - Ideal in Maryland for the mid-size estate (.pdf)
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