Warding off estate taxes

February 15, 2000: 1:05 p.m. ET

If you're married and have joint assets over $675K, consider a Bypass Trust

NEW YORK (CNNfn) - If you are a young professional couple with kids, it's time to start thinking seriously about setting up an estate plan to protect your assets - and your heirs -- from estate taxes.
    One way to do that is to establish a revocable living trust, that, upon the death of the first spouse, will branch into two trusts, one of which will not be subject to estate taxes, said lawyer John C. Suttle, a principal of the San Francisco-based firm Fotenos & Suttle.
    For instance, Howard and Nancy Smith, a husband and wife in their mid-30s, have an estate valued at $1.35 million, consisting entirely of community property assets. Their assets include a modest bank account, a 4-bedroom house, two cars and an aggressive mutual fund. The Smiths also have two young children.
    Say Howard dies first. A basic estate plan would allow for all of their assets to pass to Nancy. Under this plan, no estate taxes would be owed upon Howard's death, since the federal tax code allows a marital deduction for all transfers between spouses made while living and at death.
    But Nancy's assets would be subject to substantial estate taxes upon her death. Currently, the tax code imposes tax on estates that exceed the lifetime exemption amount. Currently, that credit is $675,000, but it will increase gradually to $1 million by 2006.
    So to protect the surviving spouse's assets, Suttle recommends Howard and Nancy set up a living trust that will split into two trusts upon the death of the first spouse. One trust will be the "Bypass Trust" or "Exemption Trust," and it will be funded with one half of the couple's assets, up to the lifetime exemption amount. The "Survivor's Trust," will be funded with the other half of the assets. Assets from both trusts will be available to the surviving spouse.
    Upon the death of the second spouse, only the Survivor's Trust will be subject to estate tax, if any. The Bypass Trust, including any appreciation, will not, and its principle is exempt from creditors' claims.
    "This is a very common plan if you've got combined assets that exceed the exemption amounts," Suttle said. But, he noted, "this assumes a nuclear family," meaning there is only one set of children between the spouses.
    If your assets keep growing and each spouse's share far exceeds the exemption amount, you might consider splitting your living trust into three trusts, the third being a "Marital Trust," Suttle said.
    While having three trusts is more complicated than two, there are advantages, he said. First, a Marital Trust offers greater protection for your kids, because the surviving spouse may not use the assets in that trust in a second marriage, for instance. And, as with the Bypass Trust, the principle in the Marital Trust is exempt from creditor's claims.