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Unified Credit Estate Tax Exemption – The Real Reason Not to Have Joint Accounts


Lots of articles have been written in the personal finance bloggersphere about whether to not to have joint accounts.

Wel, it turns out that there is a legal reason not to have a joint account. The reason is the unified credit exemption. Here is the background to this.

The IRS imposes a tax on your estate when you pass away. However, you are allowed a certain amount of exemption. Before 2001, the exemption was one million dollars. In 2007 and 2008, the exemption is $2.5mm. In 2009, it is $3mm. In 2010, the estate tax is repealed for one year. That means that anyone who passes away in 2010 will not have to pay any estate taxes (to be precise, their heirs do not have to pay any estate taxes). In 2011, the exemption goes back to $1mm.

However, even though everyone has a $1mm exemption, very few married couples fully take full advantage of this. Even, if a married has a simple “I love you” mirror will, you are still not taking full advantage of this exemption. An example below will illustrate this.

Let’s say that a married couple has $2mm in net worth. When the first spouse dies, his or her estate is $2mm. $1mm will be exempt from federal estate taxes because of the $1mm exemption. The other $1mm is not taxed because of the unlimited marital exemption (where you can give unlimited gifts to your spouse during your lifetime).

So spouse one passes away without paying any estate taxes. Spouse two has $2mm in assets. When spouse two passes away, $1mm in exempt from estate taxes. The other $1mm is taxed at 55%. So he or she has to pay $550,000 in federal estate taxes. The couples’ heirs (presumably their children) inherit $1.45mm.

Unified Credit Trust or Bypass Trust

The basic method to fully take advantage of the unified credit exemption is to use a unified credit trust (also called bypass trust). This is how it works. When spouse one dies, he or she transfers $1mm into a unified credit trust (the exact credit exemption amount). The trust passes to spouse two tax free. The other $1mm passes tax free because of unlimited marital deduction. But this is the same as the previous example, you are wondering? But wait, here is where it gets interesting.

Unlike the previous example, this time spouse two has only $1mm in assets. The other $1mm is in the bypass trust. When spouse two passes away, the assets in the bypass trust passes to her heirs tax free. The other $1mm is tax free because of the credit exemption. The result is that the couples children inherit $2mm instead of $1.45mm.

Bypass Trust Cannot Accept Assets from Joint Accounts

However, the catch is that you cannot fund a bypass trust or any trust with assets from a joint account. That is why estate lawyers will ask a couple to retitle their assets when doing estate planning with trusts.

In essense, this is the true reason why you should not have joint accounts.

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