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Taking Care of Mom and Dad: Marital and Bypass Trust

This is the tax planning cornerstone for many combined marital estates (all property owned by the husband, the wife and jointly) worth over $1 million in 2002. In these trusts, your parents serve as their own trustees. Most people specify the broad outline of their intentions at the time the trust is prepared but leave themselves great discretion as to all kinds of details.

While both spouses are alive, there can be a single initial trust, that is revocable and completely in their control. It is similar to, and serves all the purposes of, a simple living trust. The initial trust ends at the first spouse's death, by splitting into two new trusts ("A" and "B").

The A trust is also called the "marital deduction trust." Property in this trust is absolutely and completely under the control of the surviving spouse, who can even revoke the trust at any time.

The B trust (some planners joke that B refers to the "below-theground" spouse) is irrevocable, and makes use of the dead spouse's estate tax shelter. The B trust is designed for the ultimate benefit of heirs; it's designed to conform to the federal estate tax "shelter limit."

The B trust is also called the "bypass trust," because property in it bypasses taxation.

The tax goal of the B trust is to get this money out of your parents' combined estate, so that it escapes estate taxation after the surviving spouse's death.

With proper planning, both spouses add a disclaimer clause in their wills giving the surviving spouse the right to disclaim as much of her inheritance from the other as she wants. Anything she disclaims goes into the tax shelter trust, which pays her income and -- at her death -- goes to the kids. The trust, also set up in a will, is just a shell unless the surviving spouse disclaims money to fund it.

If your mom inherits $1.5 million from your dad and the estate tax exclusion is $1 million, she can disclaim $500,000 to the trust. Her estate won't be taxed; her heirs inherit $1 million from her and $500,000 from the credit shelter trust -- both amounts untaxed because neither is above the $1 million limit.

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