Avoid the Funding Trap for Trusts — Control Taxes by Monitoring When and Where Assets Go

Estate Planner Nov-Dec 1997

Estate planning focuses on transferring your assets as you desire while minimizing estate taxes. Although you may set up several trusts to achieve these goals, you might not consider the tax impact of how and when assets pass to each trust. The actual funding of these trusts, however, can greatly affect the amount of taxes due and how much goes to each beneficiary. The following example illustrates the potential impact.

The Estate Plan

John and Georgia were married, and each had significant assets. They structured John’s estate plan so that their two children would receive something on his death even if he died before Georgia. The will allocated:

  • John’s $1 million generation-skipping transfer (GST) tax exemption to two trusts — $500,000 for each child.
  • 50% of his gross estate, after debts and expenses, to a marital trust.
  • The remaining estate, after distributions and estate taxes, to the children.

Execution of the Plan

On John’s date of death, June 1, 1997, his estate was valued at $10 million. Debts and expenses were $100,000. The estate would be divided as follows:

  • GST tax exempt trusts: $1,000,000
  • Marital trust: $4,950,000
  • Federal and state estate taxes: $2,170,500
  • Children’s share (residue): $1,879,500

How John’s will was drafted, the timing of funding the distributions under the will, and the change in the value of assets from the date of death to the date of funding all could affect the plan and result in unexpected or unintended consequences.

Unexpected Capital Gains

For example, assume that John had the assets listed in the box below and the distributions were not funded until Dec. 1, 1998. If the will specifically stated that the distribution to the GST trust was to be a pecuniary $1 million, and the executor used the X Corp stock to satisfy this distribution, the simple act of funding the distribution would produce a capital gain to the estate of $500,000. This would result in a capital gains tax of approximately $100,000, leaving less remaining in the estate for the children.

If John had the same assets, but funding occurred closer to the date of death with the Y Corp stock and one-half the X Corp stock, no gain would occur, and significant appreciation would enure to the benefit of the GST trusts.

Unintended Valuation Effects

Valuation issues also can play a role. If, under the prior example, the executor was required to fund the marital trust using date of death values, waiting to fund might result in serious overfunding of the marital share. This would leave little, if anything, for the residuary beneficiaries after all taxes and expenses had been paid.

Thus, if the Business Z asset was used to fund the marital share, Georgia would receive $6.5 million in current assets and the children would be left with $829,000, less any tax that may result from having to sell assets to pay estate tax. This not only might be undesirable, but it also might cause a rift between the surviving spouse and the residuary beneficiaries.

Monitor Funding To Avoid the Unexpected

While you can’t always control the post-death appreciation or depreciation of assets, closely monitoring the funding situation can avoid the unexpected. If you would like more ideas on funding your trusts effectively, we’d be glad to help.


John’s Assets Date of Death Value Date of Distribution Value

Publicly traded X Corp stock $ 500,000 $ 1,000,000
Publicly traded Y Corp stock $ 750,000 $ 1,000,000
Interest in closely held Business Z $ 5,000,000 $ 6,500,000
Investment real estate $ 3,750,000 $ 2,000,000

TOTAL $ 10,000,000 $ 10,500,000