Exemption Trust

An exemption trust is a trust designed to drastically reduce or eliminate federal estate taxes for a married couple's estate. This type of estate plan is established as an irrevocable trust that will hold the assets of the first member of the couple to die and not pass them along to the surviving spouse. As its name suggests, an irrevocable trust cannot be changed or invalidated without the permission of the trust beneficiary. A primary benefit of an irrevocable trust is that it removes assets from the grantor’s taxable estate, thereby diminishing the estate’s tax liability. Assets in an irrevocable trust could include one or more of the following: cash, investments, a house, life insurance policies, a business, precious gems, fine arts or antiques, to name a few.

An exemption trust is a popular estate planning tool for many affluent married couples. The primary goal of an exemption trust, which is also known as a bypass trust or credit shelter trust, is to mitigate a couple’s federal estate tax liability. With an exemption trust, the assets of the first member of the couple to pass away are not inherited by the surviving spouse, unlike the provisions of many wills. Instead, the surviving spouse is “bypassed” and the deceased’s assets are held in a trust. Then, when the surviving spouse dies, the assets of the trust are distributed to the beneficiaries, typically the couple’s children. Because the surviving spouse did not inherit the assets directly, the beneficiaries are not levied any estate taxes when they receive the trust assets after the surviving spouse dies.  

Another benefit of an exemption trust is that before the surviving spouse passes away, they still retain a number of access rights to the trust assets during the remainder of their lifetime. For example, a surviving spouse can tap into both the trust’s income and its principal in order to pay for certain medical or educational expenses.

The new tax law passed by Congress in late 2017 raises the exemption limit for estate taxes. In fact, it doubles the cash value amount that couples can transfer without being subject to estate taxes. The prior exemption amount was just shy of $5.5 million per person. But now, thanks to the recent tax reform, the tax exemption has increased to roughly $11.2 million for tax years 2018 through 2025.

Therefore, if the gross value of an exemption trust grantor’s estate is less than $11.2 when that individual dies, no estate taxes have to be paid. And even if the total value of the estate exceeds the $11.2 million limit, only the amount in excess of the exemption level is taxable. In other words, if an estate is worth $100,000 more than the exemption limit, only the $100,000 is taxed, not the $11.2 million.