March 7, 2018
In light of the recent changes to the tax law, some readers may have estate plans in place that were created at a time when the exemptions were significantly lower and which not only may no longer be beneficial but which actually may be detrimental to their heirs. As a result, it is possible that some readers may benefit from unwinding previously created structures under certain circumstances.
As you may recall from our recent Wealth Advisory newsletter, the new tax law increases both the federal estate and gift tax exemptions to $11.2 million per person while continuing to permit assets owned at death to receive a step up in basis to their date of death values. Given that these exemption amounts are far more generous than they ever were, it is possible that clients who previously made lifetime gifts to minimize the estate tax bite may, under the current transfer tax regime, no longer have taxable estates (even assuming that the transferred assets were to be includible in their estates) and thus would greatly benefit from an income tax perspective by undoing their planning and having the assets includible in their estates.
EXAMPLE 1: Let's assume that married clients have a present net worth of $5 million after husband funded a trust several years earlier with cash of $1 million. Let's further assume that the trust invested the cash in securities which have appreciated in value to $3 million. When husband dies the trust would pass to their heirs estate tax free. However, the trust assets would still have the $1 million basis in the securities and thus a $2 million capital gain would be lurking upon the sale of the assets which would translate into more than $400,000 of capital gains tax. However, if the trust had a mechanism for unwinding the transfer (i.e., wife is a beneficiary and could receive a distribution within the discretion of the trustees of all of the trust assets), their estates would still pass estate tax free due to the increased exemption and those assets would receive a stepped-up basis at death eliminating the capital gains tax.
In addition to the need to reconsider one's prior lifetime planning, many surviving spouses may also find it extremely valuable to revisit the planning that was done under their deceased spouse's Will.
EXAMPLE 2: Let's assume that husband died when the federal estate tax exemption was $2 million and his Will provided that his exemption amount was to pass to a credit shelter trust for the benefit of his wife and issue. Let's further assume that the trust assets have increased in value to $5 million and wife has $5 million of other assets. Similar to the results in Example 1, there should be no federal estate tax payable if wife dies when the exemption is over $11 million, and thus all of her assets and the credit shelter trust assets should pass to their heirs transfer tax free. However, as was the case with Example 1, there is significant appreciation in the credit shelter trust assets that will not receive a step up in basis when wife dies unless the trust assets are somehow includible in wife's estate and thus wife might very well be advised to unwind the credit shelter trust and hold the appreciated assets until death to ensure that the capital gains inherent in these assets disappears.
While the examples above do not factor in such things as the applicable state estate tax, the sunset provisions in the Act that make the exemptions revert to their 2017 levels beginning in 2026, and other benefits that trusts provide (including creditor protection), they make clear that clients with estates below the exemption amounts who have done prior planning or who are beneficiaries of trusts created for their benefit should carefully review their planning to determine whether it might be advisable to make any changes.