Does your trust need a tune-up?
BY KELLY GREENE,  The Wall Street Journal — 04/16/11

Families can now shelter a far greater amount of their assets from 
estate and gift taxes. But they may need to revisit their estate 
plans.

The tax law that Congress enacted in December upped the amount 
individuals can leave their heirs, or give away during their lifetime, 
to $5 million from $1 million without incurring estate or gift taxes, 
which top out at 35%. Congress also passed a "portability" measure 
allowing spouses to combine their exemptions up to $10 million.

But both provisions are set to lapse after 2012. And in a climate of 
budget cuts and renewed talk of tax increases on the wealthy, no one 
knows if the higher exemption amounts will stick. Experts expect 
portability to be extended — though states that levy their own estate 
taxes haven't yet adopted it, according to CCH Wolters Kluwer.

All this means that families need to be prepared for any contingency. 
The way many estate plans are currently worded could cause them to 
backfire, either by triggering unnecessary state estate taxes or even 
accidentally disinheriting a surviving spouse.
'You change it'

"We have at least 20 to 30 married couples every month who come in 
with the question, 'With the new estate-tax law, what do we do with 
our trust? Do we change it or get rid of it?'" says Philip Kavesh, an 
estate-planning attorney in Torrance, Calif. "The answer is, you 
change it."

One of the most commonly used estate-planning tools is the so-called 
bypass trust — also called a "credit shelter" or "AB" trust — which 
can double the amount a couple can shield from estate taxes.

Here is how the strategy typically works: When one spouse dies, the 
maximum amount exempt from estate taxes goes into a trust, with both 
the surviving spouse and the couple's children named as beneficiaries. 
Typically, the surviving spouse uses the interest; after the second 
spouse's death, the remaining assets pass, tax free, to the couple's 
heirs, preserving both individual exemptions.

Herb and Kathe Cook, a retired magazine publisher and Fannie Mae 
executive, respectively, set up bypass trusts five years ago after 
they retired, fine-tuning them to Washington state law after moving to 
the Olympic Peninsula from Ohio.
Enough wiggle room

They re-evaluated them after the law change and decided to keep them, 
since the trust documents already provided enough wiggle room: The 
trust language lets the amount sheltered increase along with the 
government estate-tax exemption limit, and it also would let the 
survivor tap the principal if needed.

Many older bypass-trust plans lack such a provision. Building in such 
flexibility is key to a successful trust at a time when the estate-tax 
law is in such flux, says the Cooks' adviser, John Schuman, a 
certified financial planner, CPA and attorney at Budros Ruhlin & Roe 
in Columbus, Ohio.
Waiting for congress

Since Mr. Cook is 69 years old and Ms. Cook is 62, he estimates that 
they both could live at least a few more decades, potentially leaving 
their children with a $10 million to $15 million inheritance.

"We're right in that cusp area where we aren't quite sure what is the 
appropriate thing to do, so we're waiting to see what Congress does 
after 2012," he says.

Many families also will want to consider capping the amounts that 
automatically flow into a bypass trust after the first spouse's death, 
says Jonathan Graber, a partner at Katten Muchin Rosenman in Chicago. 
Volatile markets and the higher estate-tax exemption could mean a 
bypass trust winds up with the bulk of an estate. In a worst-case 
scenario, the surviving spouse would have to ask the children for 
money to cover living expenses.

Another reason to consider a cap: Sixteen states and Washington, D.C., 
levy their own estate tax, according to CCH — and in many of those, 
the exemption is substantially lower than the federal government's. 
That could result in a hefty state estate-tax bill.

New York, for example, allows only $1 million to go to heirs free of 
estate tax. "If Mom dies with a $5 million estate that goes into a 
credit-shelter trust for Dad, you can generate more than $444,000 in 
New York estate tax," says Blanche Lark Christerson, a managing 
director at Deutsche Bank's private wealth-management unit.
Creating trust 'buckets'

Illinois's exemption is $2 million, so Mr. Graber often sets up three 
trust "buckets" for his clients: For a couple with $10 million, one 
trust bucket (after the first spouse dies) would get $2 million free 
of state and federal estate tax; the second would get $3 million 
subject to state estate tax but not the federal levy; and a third 
would get the remaining $5 million for the surviving spouse's living 
expenses.

Illinois and a handful of other states let couples put the amount 
subject only to state estate tax — the second bucket — into what is 
called a "qualified terminable interest property" trust, which 
provides a surviving spouse with income, and sometimes principal, 
while delaying estate tax until after the survivor dies.

"You're postponing the state estate tax, and you might use the money 
anyway," Mr. Graber says.

One other caveat: To take advantage of portability, you must file an 
estate-tax return upon the first spouse's death. "Preparing an estate-
tax return can range anywhere from $2,500 to $10,000," Mr. Kavesh 
says, "so the cost of setting up [bypass] trusts might actually have 
been less."
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