Does Your Estate Plan Still Need a Trust? | Rodgers & Associates
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Does Your Estate Plan Still Need a Trust?

Many trusts were set up to protect wealth from estate taxes when the estate tax exemption was only $600,000. The Tax Cuts and Jobs Act increased the estate tax exemption, but only until 2025. The exemption is indexed to inflation, and in 2020 is $11.58 million for singles and twice that amount for married couples. The exemption level is portable between spouses, elimi­nating the need for the old bypass trusts, which were used to preserve the exemption of the first spouse to die. The first spouse to die could leave $5 million to children. The surviving spouse would still have his or her own $11.58 million exemption plus the $6.58 million unused exemption of deceased spouse.

The estate tax rate is bracketed like income taxes. However, all transfers over the exemption are taxed at the top rate of 40% because the exemption exceeds all the brackets. There are some provi­sions in the estate tax that can reduce the burden or spread payments over time for family-owned farms and closely held businesses.

One of the impli­ca­tions of the higher exemption levels is that fewer people risk triggering the estate tax. Some trusts estab­lished in years past are credit shelter trusts that are no longer needed, mainly because the exemption is automat­i­cally deemed portable. Credit shelter 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 best 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 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 40% tax rate affecting wealthier taxpayers will be a more signif­icant issue when contem­plating specific estate planning strategies. Grantor trusts may be counter­pro­ductive for some families because tax rates on trust income are high.

If taxable income is:

The tax is:

Not over $2,600 10% of taxable income
Over $2,600 but not over $9,450 $260 plus 24 percent of the excess over $2,600
Over $9,450 but not over $12,950 $1,904 plus 35 percent of the excess over $9,450
Over $12,950 $3,129 plus 37 percent of the excess over $12,950

2020 tax rate schedule for estate & trusts. Source: IRS​.gov

It will be essential 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 or inher­i­tance tax will need to consider the state laws before removing trust provi­sions. The step-up in cost basis for appre­ciated assets is still in effect. A step-up in basis reflects the changed value of an inherited asset. For example, a taxpayer purchases stock at $10 per share. The stock is $50 per share when they die and leave the shares to an heir. The shares receive a step-up in basis, making the cost basis for the shares the current market price of $50.

In some cases, paying the state inher­i­tance tax for the heirs to step-up their cost basis and avoid capital gains tax may 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 the lifetime. Assets trans­ferred by gift retain the donor’s basis except if the asset value on the date of the gift is less than the donor’s cost. A little-known rule gives the benefi­ciary a split basis, which prevents the recipient 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 to review your estate plan regularly and eliminate trusts or other dispo­si­tions that are no longer needed.

Rick’s Insights

  • The Tax Cuts and Jobs Act increased the estate tax exemption but only until 2025.
  • The exemption level is portable between spouses without making provi­sions in a trust or will.
  • Credit shelter trusts are easy to change when both spouses are still alive because they still are revocable during that period.