How a living trust in California can reduce estate taxes

As part of the estate planning process, it’s necessary to determine what documents are needed for estate planning.  For most California residents, having a living trust is imperative.  One reason for this is to reduce the potential tax liability for your heirs.  You’ll want to understand how a living trust in California can reduce estate taxes that they may be required to pay.

Estate taxes, often termed “death taxes,” are levied on an individual’s estate after their passing, prior to the distribution of assets to heirs. For many, especially those with substantial assets, estate taxes can take a significant portion of what they leave behind. However, utilizing a living trust in California can offer avenues to potentially reduce or even eliminate these taxes.

Let’s dive into the mechanics of how to create a living trust in California that can help when tax time comes around:

  1. The AB Trust System (Bypass or Credit Shelter Trust):

Traditionally, married couples in California have utilized an AB Trust system to maximize their federal estate tax exemptions. Here’s how it works:

  • Upon the first spouse’s death, the trust splits into two parts: the “A Trust” (or survivor’s trust) and the “B Trust” (or bypass/credit shelter trust).
  • The B Trust is funded up to the deceased spouse’s federal estate tax exemption limit. The A Trust contains the surviving spouse’s assets and any assets exceeding the deceased’s exemption limit.
  • The B Trust’s assets can grow and benefit the surviving spouse, but they aren’t considered part of the surviving spouse’s estate. Thus, when the second spouse passes away, only the assets in the A Trust are subject to estate tax.
  1. Qualified Terminable Interest Property (QTIP) Trusts:

This is another type of marital trust that can be set up within a living trust. It allows the first spouse to pass assets to the trust while providing income from the trust to the surviving spouse. Upon the death of the surviving spouse, the trust assets pass to the beneficiaries designated by the first spouse, potentially bypassing additional estate tax.

  1. Charitable Remainder Trusts (CRT):

For those inclined toward philanthropy, a CRT allows one to transfer assets to the trust and receive an income stream for a specified period. After this period, the remaining assets go to a charitable organization. Not only does this provide an income tax deduction when the trust is funded, but the assets also aren’t part of the grantor’s estate, thus avoiding estate tax.

  1. Irrevocable Life Insurance Trusts (ILIT):

Though a living trust is typically revocable, one can create an ILIT to hold life insurance policies. By doing so, the death benefits aren’t considered part of the estate. While the policyholder must give up control over the policy, the benefits can pass to heirs without incurring estate taxes.

  1. Gifting Strategies:

While this isn’t a trust per se, a comprehensive estate plan using a living trust might incorporate a gifting strategy. One can gift a certain amount annually to individuals without incurring gift tax. Over time, this can significantly reduce the size of an estate that would be subject to estate tax.

  1. Unified Credit:

Everyone gets an exemption amount (unified credit) from the federal estate tax. By setting up a living trust properly, couples can ensure they utilize both their exemptions, thereby doubling the amount of assets protected from the estate tax.

Note on California Estate Tax:

As of the last update in 2022, California doesn’t have a separate state estate tax. However, estate planning must still consider the federal estate tax and any changes to tax law that may occur in the future.

A Few Final Thoughts

While living trusts offer a plethora of strategies to potentially reduce estate taxes, their complexity necessitates a detailed and individualized approach. It’s essential to obtain experienced guidance. The experts at Shoup Legal, estate planning attorneys in Temecula, CA, are well-versed in crafting living trusts tailored to the unique needs of California residents, ensuring maximum protection against estate taxes.

Please note: The information provided in this article is intended for general informational purposes only. It is not, and should not be considered as, legal or tax advice. The content of this article is not a substitute for professional advice specific to your individual circumstances.

Estate planning and tax laws are subject to change, and the application of legal principles can vary depending on the unique details of your situation.  Now that you realize how a living trust in California can reduce estate taxes, it is strongly recommended that you consult with a qualified attorney or tax professional to discuss your specific needs and obtain professional guidance tailored to your estate planning requirements.