The Internal Revenue code ("IRC") and North Carolina law grant an unlimited gift and estate tax deduction for all transfers to a spouse whether made during life or death. Thus, anyone may give or leave his or her entire estate to the surviving spouse without gift or estate taxes and, furthermore, may do so in such a way as to minimize taxation of the portion for the benefit of their family after the surviving spouse's death.
The following qualify for marital deduction:
outright gifts and bequests
joint and survivor annuities
certain life estates in real estate
trusts of which the surviving spouse is sole income beneficiary for life
The following are useful tools and concepts to facilitate planning for your family after your passing.
MARITAL DEDUCTION ("Q-TIP") TRUST: The IRC and North Carolina law permit an unlimited marital deduction in the estate of the first spouse to die, for a trust which provides for all income to the surviving spouse for life. Upon his or her death, the balance in the trust will pass to the person or persons named in the trust clause. This kind of trust - called a "Q-TIP" trust - enables the executor to elect to qualify all or a portion of the trust for the marital deduction, thereby allowing flexibility in post-death planning.
CREDIT SHELTER TRUST: Substantial estate tax benefits can usually be obtained by combining the use of the marital deduction with a trust of the amount of property that can pass free of Federal estate tax in the estate of the first spouse to die. A trust (a "credit shelter trust") of this maximum amount in the first estate will be sheltered from Federal and North Carolina estate and inheritance taxes in the estate of the surviving spouse. This trust is most often either a family trust (for the benefit of all family members), or a marital trust (for the sole benefit of the surviving spouse). The balance of the first estate over the amount of the credit shelter trust can pass tax-free to the spouse under the marital deduction, either outright or in trust. All Federal taxes are avoided in the first estate, and the property in the credit shelter trust escapes taxation in the survivor's estate. The credit shelter amount can also be passed outside a trust by direct transfer to other family members if that is an appropriate step to take in the overall plan.
Thus, when the credit shelter and the surviving spouse's exemption are combined, a maximum of approximately $1.2 million in 1996 can pass through both estates free of Federal estate taxes. The combined amount increases as a result of the 1997 federal legislation as follows: 1998, $1,250,000; 1999, $1,300,000; 2000 and 2001, $1,350,000; 2002 and 2003, $1,400,000; 2004, $1,700,000; 2005, $1,900,000; 2006, $2 million.
A note of caution about credit shelter trusts: A credit shelter trust can only be funded by property held in the individual name of the decedent; it is not generally available where property is jointly-held since this property passes automatically to the survivor. And jointly-held property between spouses will not be available to fund the unified credit, because the value of the property which passes to the surviving spouse automatically qualifies for the marital deduction.
CHARITABLE DEDUCTIONS: All outright bequests to churches, synagogues and other qualified charities are deductible for estate tax purposes. The value of trust principal which is given to charity following the death of the income beneficiary - usually a family member - is also partially deductible if the trust is properly drafted. Other trusts paying "income" to charity with the assets going to a family member at the termination of the trust generate significant charitable deductions. People who have supported charities during their lifetime may wish to consider charitable gifts in their Will as long as the security of the family is not affected.
DISCLAIMERS: Where appropriate, provision may be made in a Will which anticipates a disclaimer (i.e., a renunciation) by the surviving spouse or other beneficiary of all or a portion of a bequest or devise, with the effect that the disclaimed property passes without gift tax to others or is added to a credit shelter trust. Disclaimers must be made within 9 months of the death of the first decedent if they are to avoid gift tax.
JOINTLY-HELD PROPERTY: Only one-half of the value of property held by spouses in joint ownership with the right of survivorship is includable in the estate of the first spouse to die unless that property was purchased solely by the decedent's spouse income or resources prior to 1977. Because the property passes to the survivor and will qualify for the unlimited marital deduction, the inclusion will have no significant estate tax effect. However, in many cases, the survivor will have a different basis for the capital gain purposes should he or she sell the property: one-half will be the value of a half interest in the property as of the date of the death of the first decedent; the other half will be one-half of the historical pre-death adjusted cost basis (purchase price as adjusted) of the property in the hands of the spouses. Joint property held by a non-spouse results in a presumption that the property is fully includable in the estate of the first of the joint tenants to die unless it is proven that the survivor contributed to the purchase of the property.
EMPLOYEE BENEFITS: Although an estate tax deduction is no longer available for lump sum distributions under qualified pension and profit-sharing plans, there are some planning possibilities that remain for approved plans. For example, the designation of a spouse as a beneficiary of a plan would qualify the employee benefit for the marital deduction. There also are a variety of critical income tax options available to a plan participant or a beneficiary of a plan which should be discussed with your tax advisor, especially if you are planning your retirement.
THE IRREVOCABLE INSURANCE TRUST: An important way of avoiding estate taxes continues to be the ownership of life insurance by a trust. If a new policy is purchased by a properly drawn trust, the entire proceeds of the policy can pass through the estate of both spouses, without tax. If an existing policy owned by the insured is transferred to a trust, the insured must survive such transfer by three years in order for the proceeds to be free of estate taxes. In each case, the trust must be irrevocable - a fact which requires that the most serious consideration be given before such a trust is created. The trust agreement must be carefully drafted to assure family security and tax avoidance.
ANNUAL GIFT TAX EXCLUSION: The amount of gifts that an individual can make without incurring gift tax liability is now $10,000 per donee per year. This amount will be indexed after 1998. This means that $20,000 may be given by a married couple per year to each child, grandchild, or others without incurring gift taxes (regardless of whose property is given). Moreover, an unlimited gift tax exclusion is provided for amounts paid on behalf of the donee for medical expenses and school tuition, provided that the payment is made directly to the school, doctor, hospital, etc. who or which provides the service. A payment made directly to a child or grandchild for tuition will not qualify for the exclusion. The IRC eliminates most of the income tax advantages of trusts for children. Nevertheless, various trust options are still available to achieve income, gift and estate tax savings in relation to gifts for children or grandchildren. These include "grandparent trusts" which permit funding of educational or similar trusts up to the $10,000-$20,000 annual gift exclusion and various forms of charitable trusts.
GENERATION SKIPPING TRANSFER TAX - (GST TAX): The GST tax in general imposes a tax at a rate of 55% on all transfers outright or in trust for grandchildren or more remote descendants to the extent that the aggregate of such transfers exceeds a $1,000,000 total exemption per transferor. This amount will also be indexed after 1998. Thus, for example, once the exemption has been consumed, a trust for a child for life, with remainder to grandchildren, is subject to the tax when the child dies notwithstanding a gift or estate tax was paid upon the initial transfer. The provisions of the GST are enormously complex. Good estate planning can avoid or minimize the imposition of the tax.