Once the creditors have been taken care of and tax returns filed, it’s time to move out of the administrative phase and start distributing assets. When there is a surviving spouse, the trust will often continue for his or her benefit. These after death trusts are known as “testamentary trusts.” When there is a testamentary trust for the surviving spouse’s benefit, the trustee will “fund” assets into a “credit shelter/bypass” or “marital” trust.
A credit shelter trust is also known as a bypass trust—both serve the same function to consume the decedent spouse’s federal estate tax exemption. Typically, to the extent that the decedent spouse has exemption, that amount is transferred to the credit shelter/bypass trust. So if the decedent died with $3 million of assets and his available federal estate tax exemption was $5 million, then all $3 million could be funded into the credit shelter/bypass trust.
If the decedent’s trust was more than whatever the available exemption amount is, then that overage is usually transferred to the “marital trust” that will qualify for the unlimited federal estate tax marital deduction, thereby deferring any estate tax until the surviving spouse’s death.
So if the decedent died with $7 million of assets and his available federal estate tax exemption was $5 million, then $5 million would be funded into the credit shelter/bypass trust and the excess $2 million would be funded into the marital trust. Typically, no estate tax would be paid at this time, since the marital trust would qualify for the marital deduction.
There are always exceptions to the above scenarios. In 2010, the estate tax law was changed to allow for “portability,” which means that any unused exemption for one spouse can be used for the other, so long as a timely federal estate tax return is filed. What this means is that there may be less use of credit shelter/bypass trusts and more use of marital trusts to get two step-ups in tax cost basis (discussed in Chapter Eight) for the same assets—one on the first spouse’s death and then another step-up on the surviving spouse’s death.
In larger estates where the generation-skipping tax exemptions are being used, there could be a further subdivision of the trust held for the surviving spouse. I discuss these trusts in greater detail in Chapter Twelve.
These are all fairly advanced topics that I am not going to cover in great detail here. My firm’s probate and trust administration process, The Estate Settlement Program®, that I describe in Chapter Eighteen will work to help the client both understand and make decisions that should result in the best tax outcome for the family.
Once the spouse’s trust is funded, then certain things need to happen:
- The attorney or CPA will typically apply for a new taxpayer identification number for the testamentary trust;
- The financial advisor will work with the trustee (in many cases, the surviving spouse serves as trustee) to discuss which assets are funded into what testamentary trust, and will also discuss whether the mix of assets is appropriate;
- A final accounting describing the income, expenses, capital gains and losses, as well as other significant items will be prepared and signed off by the surviving spouse and the remaindermen beneficiaries (the beneficiaries who inherit when the surviving spouse dies—typically the children, but also see Chapter Twelve below).
From this point forward, the trust will benefit the surviving spouse for the rest of her life. Income is usually distributed and paid to her for her normal everyday living expenses. If the income is insufficient for her needs, and if the testamentary trusts provides for principal distributions, then additional amounts may be distributed for her health, maintenance, and support.
How the credit shelter/bypass or marital trust is administered from this point forward is unique to its provisions. A marital trust, by definition, only benefits the surviving spouse for the rest of her life. A credit shelter/bypass trust, however, may benefit a group of beneficiaries including surviving spouse, children, and grandchildren. When a group of beneficiaries all benefit from a trust, then it will be important for the trustee to meet with his or her team of professionals to determine when and how distributions should be made.
Keep in mind that the trustee still has the duties to administer the trust impartially as (discussed in Chapters Three & Four) as well as following the prudent investor rules. A conundrum for the surviving spouse who is serving as trustee is the balance between maximizing her income and growing the assets for the remaindermen beneficiaries.
An income tax return should be filed annually, although when the trust distributes out all of its income, then no tax is paid. Instead, the beneficiary (the surviving spouse) who receives the income will pay the income tax at his or her own rates.
Annual accountings should be sent to the remaindermen beneficiaries, unless the trust contains a “designated representative” which under Florida law allows the trustee to circumvent the annual accounting requirement.