A husband and wife may have set up an A/B Trust to protect the first-spouse-to-die’s estate tax exemption. But when the husband died, the wife forgot that she did not inherit her husband’s share of the trust assets. This particular trust provided that the husband’s share was to go into an irrevocable trust as to which the wife received mandatory income, plus principal for her health, education, support and maintenance.
The wife did not get a tax identification number for the husband’s irrevocable trust. She did not divide the assets and re-title them into the two trusts, her revocable trust and her husband’s irrevocable trust. She did not have her accountant report the income from the assets that should have been allocated to the husband’s trust on a 1041 trust income tax return for that trust. Instead, the wife reported all the income directly on her 1040 personal income tax return.
The wife has recently died. The children who are now inheriting the assets and who have been designated as successor trustees meet with the attorney who set up the trust originally. The children learn from the attorney that the wife (their mother) never called the attorney when her husband (their father) died. Therefore, the attorney did not know that the husband had died, and the attorney could not have counseled the wife about following the dictates of the trust.
The total amount of the trust assets on the wife’s death exceeded the exemption for the year that the wife died ($5,000,000 in 2011). If the wife were treated as owning all the assets, there would be an estate tax in 2011 of 35% on the equity in excess of $5,000,000. But since the total assets was well below $10,000,000, there would be no estate tax if the wife were treated as only owning her half of the assets.
At the meeting between the attorney and the children, strong suggestion was made by the attorney to go back to the year of the husband’s death and divide the assets between the two trusts, including doing new deeds and re-titling the bank and brokerage accounts. The attorney recommended that the irrevocable trust’s share of the income for the periods on and after the husband’s death be nomineed from the 1040 to the 1041 and then K-1ed back to the wife’s 1040. The attorney recommended that estate tax returns be prepared both for the husband and for the wife, and that the husband’s estate tax return show that his share of the assets passed to his irrevocable trust rather than to his wife.
The children ask the attorney whether doing the above project will guarantee that the husband’s assets will be excluded from the wife’s estate for estate tax purposes. The attorney says that no guarantee is possible, that the IRS may contend that because the wife did not honor the trust and because she treated the husband’s assets as if she owned them, that the IRS should be able to do the same. On the other hand, trying to repair the situation and to go back and do what should have previously been done is the wisest course of action.