Do You Still Need Your Trust? - Rodgers & Associates
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Do You Still Need Your Trust?

Money and Lock

Many trusts were set up to protect wealth from estate taxes when the estate tax exemption was only $600,000. The American Taxpayer Relief Act of 2012 (ATRA12) increased the 2013 exemption to $5.25 million for gifts made this year and the estates of decedents. The exclusion is indexed to inflation and the amount will be $5.34 million in 2014.

Another important aspect of ATRA12 was the decision to make the porta­bility rules for a deceased spouse’s unused estate tax exemption amount permanent. Porta­bility was first intro­duced in the Tax Relief Act of 2010 as a provision allowing the unused portion of a deceased spouse’s estate and gift tax exemption to be trans­ferred to the surviving spouse. This new “porta­bility” of the unused exemption meant a couple could exclude the first $10,000,000 of their estate without the need for a bypass trust. In order to claim porta­bility, estates must file a timely estate tax return (even if not otherwise obligated to do so) in order to make a porta­bility election and report the amount of the unused exemption that remains from the decedent as a carryover to the surviving spouse. In 2014, the use of porta­bility will allow $10.68 million to be excluded from a married couple’s estate. The Supreme Court’s ruling on the Defense of Marriage Act this year will extend porta­bility to same sex couples who are legally married.

One of the impli­ca­tions of ATRA12 making the new exemption levels permanent is that fewer people risk triggering the estate tax. Some trusts estab­lished in years past are no longer needed especially credit shelter trusts. These trusts are often referred to as AB trusts because one trust (an “A” trust) holds assets for the survivor’s use, and the second trust (a “B” trust) sets aside certain assets for heirs. The trust was designed to capture the exemption from the first to die and pass it along to the heirs.

Credit shelter trusts are easy to change when both spouses are still alive, because they are still revocable during that period. When one spouse dies, however, the trusts become irrev­o­cable. That’s when it gets tricky. The Internal Revenue Service’s rules for termi­nating a trust early are complex. The first course of action is to review your estate plan while both spouses are living and get rid of trusts which are no longer needed.

Many estate plans simply contained testa­mentary trust provi­sions in the will to establish the credit shelter trust if needed upon the death of the first spouse. This situation is easily remedied by updating wills. The will could be rewritten without the trust language. Another option provides for a “disclaimer” trust, giving the surviving spouse the option of funding the trust or not. The survivor could decide the estate is never going to be big enough to exceed the exemption amounts and not fund the credit shelter trust. On the other hand, the survivor may want to fund the trust if there are suffi­cient assets in the survivor’s name and the estate risks being taxed if it grows in the future.

The new tax rates affecting wealthier taxpayers will be the bigger issue when contem­plating certain estate planning strategies. Grantor trusts may be counter­pro­ductive for some families because the grantor pays the tax at the new tax rates. It will be important to review these trusts especially if the benefi­ciaries are in a lower tax bracket. It may make sense to terminate these trusts and make distri­b­u­tions to benefi­ciaries. Such planning would take advantage of the benefi­ciaries’ lower brackets, but the purpose of the trust should be reviewed.

Taxpayers residing in states retaining an estate and/or inher­i­tance tax will need to consider the state laws before removing trust provi­sions. The step-up in cost basis for appre­ciated assets has been retained in ATRA12. In some cases paying the state inher­i­tance tax in order for the heirs to step-up their cost basis and avoid capital gains tax is going to be the most cost effective option. The effect of the increase in capital gains tax should be considered when deciding to make gifts of appre­ciated assets. There is no step-up in basis for assets gifted during lifetime. Assets trans­ferred by gift retain the donor’s basis except if the asset value on the date of gift is less than the donor’s cost. A little known rule gives the benefi­ciary a split basis, which prevents the benefi­ciary from realizing the loss on the sale of the asset.

Trusts are easy to unwind if they are still revocable or haven’t been funded. Make it a priority this year to review your estate plan and eliminate trusts that are no longer needed.

Rick’s Tips:

  • The American Taxpayer Relief Act of 2012 increased the 2013 estate tax exemption to $5.25 million for gifts made this year and the estates of decedents.
  • In 2014, the use of the new porta­bility provision will allow $10.68 million to be excluded from a married couple’s estate.
  • Credit shelter trusts are easy to change when both spouses are still alive, because they still are revocable during that period.