Len Cason is a partner in the law firm of Hartzog Conger Cason & Neville, Oklahoma City, Oklahoma.  He leads a practice group within his firm that represents affluent families across a broad spectrum of matters, including family estate and wealth transfer planning, income tax planning and tax controversies, overview of financial and investment matters, and representation of family businesses, including acquisitions and sales of businesses.  He is a Fellow in both the American College of Tax Counsel since 1989, and the American College of Trust and Estate Counsel.

Len first introduced the "Poorer Spouse Funding Technique" in a July 2002 Estate Planning Journal article (discussed by Andy DeMaio in "Creative Funding of the Bypass Trust in LISI Estate Planning Newsletter No. 642.)  Len followed up Andy's comments with his own "Poorer Spouse Funding Technique Revisited" in LISI Estate Planning Newsletter # 647.

Now Len has created an innovative technique designed to avoid the overfunding (or in some cases even funding) of a credit shelter trust at the death of the first spouse, while still avoiding estate tax at the second death. 

So, how much do you fund into the credit shelter trust? 

Len's Three Bears answer: 

"Just enough!"

Len explains this technique below. (Sample form provisions can be found in his article in the June, 2008 edition of Estate Planning magazine).

EXECUTIVE SUMMARY:

The Problem:

Husband and Wife have a combined estate that is not huge, but which they think will be estate taxable at the second death.  They don't want to create a credit shelter trust for the survivor of them unless necessary to avoid estate tax at the second death. 

They each have reciprocal wills, which leave the maximum estate tax exempt amount to a credit shelter trust for the survivor.  These wills were created back when the estate tax exclusion amount was $600,000. 

Today, that amount is $2,000,000, going to $3,500,000 in 2009, and who knows where it will go from there.

Whether or not the couple will need a credit shelter trust depends on the estate tax exclusion amount and the size of their combined estates when the first death occurs, as well as the projected size of the surviving spouse's estate and the estate tax exclusion amount at the time of the surviving spouse's death. 

None of these amounts are completely predictable. 

Further, they may decide that they need a credit shelter trust at the first death, although they may not need to fully fund that credit shelter trust with 100% of the decedent's exclusion amount. 

Husband and Wife may be candidates for the "just enough" funding technique.

Example.  

Assume Husband and Wife each owns $1.5 million in assets. 

They want to leave enough property to a credit shelter trust for the survivor to the extent necessary to avoid estate tax at the survivor's death, assuming no growth in the survivor's estate after the death of the first spouse. 

Each has an old will which leaves 100% of the decedent's estate tax exclusion amount to a credit shelter trust for the survivor. 

If Wife dies in 2008 when the estate tax exclusion amount is $2 million, Wife's entire estate must be used to fund the credit shelter trust for Husband, shown as follows:

	Wife	Husband	Credit Shelter Trust
Today	$1,500,000	$1,500,000	Not created yet
Wife's death	($1,500,000)	___________	$1,500,000
	0	$1,500,000	$1,500,000

Remember that Husband and Wife only wanted to create and fund a credit shelter trust to the extent necessary to avoid estate tax at the survivor's death.  Because the exclusion amount in 2008 is $2 million, Wife could have left $500,000 to Husband, and Husband would still not have an estate that exceeds his exclusion amount. 

This example illustrates why, for an increasing number of married couples, the standard form will or trust provision which fully funds a credit shelter trust for the surviving spouse may be undesirable.  To the extent that the estate tax exclusion amount may increase in future years, this problem will only become worse.

THE "JUST ENOUGH" FUNDING TECHNIQUE

With this technique, the first spouse to die will leave an amount to the surviving spouse which is just enough to increase the size of the surviving spouse's potential taxable estate to the surviving spouse's projected applicable exclusion amount.

Consider the same facts as in the above example, except that Wife's will uses the "just enough" funding technique.  Wife dies in 2008 when the exclusion amount is $2 million. 

Wife leaves to Husband an amount or property which is just enough to increase his hypothetical taxable estate to an amount equal to his exclusion amount.  The remainder of Wife's estate (not to exceed her exclusion amount) will fund the credit shelter trust.

Thus, Husband receives $500,000, which increases his hypothetical taxable estate to $2 million.  If Husband dies immediately following Wife, his taxable estate would be equal to his exclusion amount, and there would be no estate tax.  Thus, the credit shelter trust is funded with just enough property so that estate tax would be avoided upon Husband's death, as follows:

	Wife	Husband	Credit Shelter Trust
Today	$1,500,000	$1,500,000	Not created yet
Wife's death	($1,500,000)	$500,000	$1,000,000
	0	$2,000,000	$1,000,000

Under these same facts, suppose the exclusion amount is $3 million. 

In that event, the just enough funding provision in Wife's will would result in all $1.5 million of her estate going to Husband, and the credit shelter trust would not be created. 

This would leave Husband with a $3 million estate, which would be protected by his $3 million exclusion amount.

IRS SAYS OK TO THIS TECHNIQUE. 

I submitted a PLR request to the IRS regarding this technique.  The IRS was requested to rule that the amount required to be distributed to the surviving spouse following the death of the first spouse qualifies for the estate tax marital deduction under Section 2056(b)(5), and the assets contained in the credit shelter trust created at the death of the first spouse to die would not be included in the surviving spouse's gross estate upon his or her death under Section 2041(a)(2). 

The IRS determined no ruling was necessary, citing Rev. Proc. 2007-1, which provides that no "comfort" ruling will be issued on an issue that is clearly and adequately addressed by existing laws.

When should a couple consider using the just enough funding technique? 

This technique should be considered if the couple believes that the creation of a credit shelter trust at the first death may be necessary to avoid estate tax at the second death, but wants to avoid creating or minimize funding of the credit shelter trust to the extent possible. 

Even if the couple believes that their combined estates will be less than the exclusion amount, there would be no harm if the just enough funding language were in the instrument, since the presence of this provision would still result in no credit shelter trust being created.

Likewise, even if the couple believes that their combined estates are sufficiently large so that estate tax can only be minimized or avoided at the second death if the decedent spouse uses all of his or her exclusion amount to fully fund a credit shelter trust, there is no downside to using the just enough funding technique.  Even in that situation, application of the technique would still result in fully funding the credit shelter trust.

The just enough funding technique should not be used if the couple anticipates that the value of the survivor's estate may increase significantly following the death of the decedent spouse.  In that situation, the technique may result in underfunding the credit shelter trust and thus creating or increasing estate tax at the second death.

Why avoid or minimize funding a credit shelter trust? 

The just enough funding technique presumes that a couple would want to avoid creating or overfunding a credit shelter trust at the first death. 

What are the disadvantages of creating or overfunding a credit shelter trust?

• ·         There is added complexity.  The assets in the credit shelter trust must be segregated from those belonging to the surviving spouse.

• ·         The credit shelter trust is a separate taxpayer, and undistributed taxable income of the trust is subject to tax at the highest marginal federal income tax rate much more quickly than taxable income of an individual.

• ·         If the survivor is the trustee of the credit shelter trust responsible for deciding upon distributions, then distributions to the survivor must be based on ascertainable standards.

• ·         Maximum funding of the credit shelter trust might necessitate funding with personal use assets, such as the family residence or personal effects.

• ·         The trustee of the credit shelter trust will have a fiduciary duty to the remainder beneficiaries, whereas the survivor would not have any such duty with respect to assets left to the survivor personally.

ALTERNATIVES THAT PREVENT OVERFUNDING OR UNNECESSARY CREATION OF CREDIT SHELTER TRUST:

One alternative is for the decedent spouse to leave everything to the surviving spouse, and then give the surviving spouse the power to disclaim all or some portion of the decedent's exclusion amount into a credit shelter trust for the survivor. 

However, there may be a risk that the survivor is either unable or for some reason unwilling to make a disclaimer in the proper circumstances, or the survivor may have inadvertently taken some action which makes disclaimer impossible.  Of course, this disclaimer technique could still be used in tandem with the just enough funding technique.

Or, the decedent spouse could leave substantially all of his or her estate into a QTIP trust for the survivor with provision for a partial QTIP election.  It would then be up to the decedent spouse's personal representative to decide how much of the qualifying trust should be QTIP'd and how much should become credit sheltered.  This alternative is workable only if the spouses are willing for the survivor's marital share to be in a QTIP.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Len Cason

CITE AS:

LISI Estate Planning Newsletter # 1312 (June 30, 2008) at http://www.leimbergservices.com/ (LISI).  Copyright 2008 Leimberg Information Services, Inc. (LISI).  Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.