Estate Tax Planning With Spousal Gifting Trusts

On January 1, 2011, estates in excess of $1 million will be subject to payment of federal estate tax.  With the federal exemption reverting to $1 million, far more Americans will be impacted by the estate tax.  For example, in 2008 the federal estate tax exemption was $2 million per person.  The estate of a New Yorker dying in 2008 with a total taxable estate of $2 million would only have paid a New York State estate tax in the amount of $99,600.  In contrast, a New York resident with a $2 million estate dying in 2011 will be subject to a combined federal and New York State estate tax of $435,000.

Given the huge sums at stake, planning to minimize estate taxes will take on greater importance. One powerful and relatively straightforward planning technique for couples with a moderate to high net worth is the Spousal Gifting Trust (“SGT”).

In very basic terms, the SGT works like this: each spouse establishes an irrevocable trust, with the wife typically serving as a Trustee of husband’s trust, and the husband typically serving as a Trustee of wife’s trust.  Depending upon the client objectives, a co-Trustee may be named as well. 

Once the SGT’s have been established, both spouses will make gifts to their respective trusts in an initial amount not to exceed $5,000 per year.  As the value of the trust grows over the years, the amount that can be gifted to the SGT annually can be increased.  Ultimately, the maximum amount that can be gifted to the SGT annually without utilizing any portion of the donor’s annual $1 million gift tax exemption is a sum equal to the annual gift exemption (currently $13,000 per year).  The beneficiary spouse will have a temporary right to withdrawal the gifted sum, typically for a period of thirty days.  If the gifted amount is not withdrawn from the SGT, it can remain in the trust and invested in whatever financial vehicles the Trustee chooses.  Once funded into the trust, the assets in the trust can be used for the beneficiary spouse’s needs at any time.

How does funding an SGT provide any estate tax benefits?  The magic here is that the amounts gifted by each spouse to their respective SGT’s will not be included in the taxable estate of either spouse!   The key is that in making the gifts to each SGT, the couple is intentionally not utilizing the “unlimited marital deduction” that would ordinarily apply to spousal gifts.  While using the unlimited marital deduction will ensure that a gift made by the donor spouse would not be taxable in his estate, the spouse receiving the gifted assets will ultimately have those assets included in her estate.  By instead gifting some of the couple’s assets to SGT’s, the assets in each spouse’s SGT will grow over time completely exempt from estate tax inclusion.

To demonstrate the cumulative power of an SGT, imagine that a husband and wife, each 45 years old, contribute $5,000 to their respective SGT’s each year for 30 years.  If the assets in each SGT were to grow annually at an average of 6%, the value of the assets in each SGT would be $395,291 – or a combined value of $790,582 – none of which would be subject to federal or New York estate tax.

A final point: despite its name, the SGT can be used by same-sex and unmarried couples to provide an estate tax-exempt repository of assets.