If you and your spouse want to institute or maintain a bypass trust structure in your planning, you have many options. The portion that isn’t passing to your spouse (and thus won’t be subject to estate tax in your spouse’s estate) is often known as the “Residuary Trust” (though it’s also called a bypass trust, a credit shelter trust, or other names). The portion that will be subject to estate tax in your spouse’s estate (but won’t necessarily pass to your spouse outright) is sometimes known as the “Marital Share” or “Marital Trust.”
Though there’s a range of options for drafting each, to achieve the estate tax goals that your overall structure is designed to address, the Marital Share/Trust must grant certain minimum rights to your spouse to qualify for the estate tax marital deduction (in other words, to ensure that it isn’t subject to estate tax on your death), while the Residuary Trust can’t grant your spouse so many rights that it becomes subject to estate tax in his or her estate.
Subject to those limitations, you and your spouse can make selections for the Residuary Trust and Marital Share/Trust that:
- Provide a specific formula for funding the Residuary Trust vs. the Marital Share/Trust. Those valuing flexibility may want to employ a “disclaimer trust” structure, which allows the surviving spouse to decide what assets will fund the Residuary Trust. Other formulas simply piggyback off the federal estate tax exemption at the time; still others might use a specific amount or percentage of the estate.
- Provide income and/or principal rights to the spouse. The spouse must be entitled to the Marital Share/Trust’s income, but doesn’t necessarily have to receive the Residuary Trust’s income. To avoid estate tax in the surviving spouse’s estate, principal rights in the Residuary Trust are limited, but there are more options for the Marital Trust. At one end of the spectrum, the surviving spouse can be given the Marital Share outright; at the other, the surviving spouse’s use of principal can be severely restricted as long as the income right is maximized (this is called a “Qualified Terminable Interest Property,” or “QTIP,” Trust).
- Provide rights to the surviving spouse to direct, or choose not to provide such a right at all, where the rest of each trust will go on the survivor’s death — in other words, whether, and if so to what extent, to grant to the survivor a power of appointment over the trust fund remaining at the survivor’s death. The surviving spouse’s power of appointment over a Residuary Trust must be limited (and the survivor can’t have any power of appointment over a Residuary Trust that was formed via a disclaimer trust structure). The survivor can be given a general power of appointment over a Marital Trust, or none at all under a QTIP Trust structure.
- Appoint a different person, persons, or an institution as trustee over either trust. There are both tax and non-tax considerations in deciding whether to name the surviving spouse as trustee.
As with all estate planning decisions, the options you choose will depend on your and your spouse’s wishes, personal and family situations, and financial and tax considerations.
Consult your estate planning advisors with any questions. Visit The Connolly Gallagher Trust & Estate page by clicking here.