January 23, 2014. What is known as the Delaware Tax Trap is a clever strategy, although not one without flaws, that does its best to hold off as long as possible a decision as to include property housed in the credit shelter trust in the surviving spouse’s estate at their death. Its merit goes to the fact that the technique even offers us a decision. As typically drafted, once the assets are placed inside the bypass trust, they are locked up. Quite clearly, the intent is to keep the assets out of the other spouse’s estate. There is no later choice. The Delaware Tax Trap, though, places a minute trigger into the scheme which can be willing tripped at a later date to dump assets into the surviving spouse’s estate. It accommodates a “wait-and-see” tentativeness. The decision to set-off the trap balances the capital gains tax against estate taxes. Will more be saved from the basis increase afforded by Section 1014 than is lost from exposure to estate tax liability? If so, then we want to employ our little sabotage.
I shan’t give much time to the mechanics, but here they are: The bypass trust is created. The trust gives the surviving spouse a limited testamentary power of appointment. The spouse then chooses to appoint the property to a new trust which in turn grants a beneficiary a present general power appointment over that trust. At this contingency, Section 2041(a)(3) operates to capture the property in the gross estate.
There are drawbacks, of course. The trap does require affirmative steps by the spouse. The spouse’s will has to be redrafted or amended to use the power. The insular asset and creditor protection is lost once the beneficiary is given the general power of appointment. As are the perpetual estate tax benefits that may, depending on jurisdiction, have been offered by a continuing trust.
All in all, the Delaware Tax Trap is a useful tool, though there may be better, and its application may be more suited to plans already in place than being an active agenda item in crafting plans going forward.
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