If your spouse is deceased and you are the current beneficiary of their trust, keep reading. You may be able to save a significant amount of money in income taxes and capital gains taxes by distributing income and/or assets out of the trust now or dissolving the trust entirely if the terms of the trust permit this.
Trusts are currently subject to the maximum tax rates on any income over $12,150. It doesn’t take much to meet that threshold. As a result of new tax laws passed in 2013, the highest income tax rate is now 39.6 percent, the maximum tax rate for long-term capital gains and dividends is 20 percent, and a 3.8 percent “Medicare” tax is imposed on investment income (including capital gains).
Many of you may have established typical revocable trusts that would split into a marital and family trust at death in an effort to avoid payment of federal estate tax. A few years ago, that likely made perfect sense. However, many of you likely face a much different set of circumstances now that do not include a risk of owing federal estate taxes. As a result, there may be no reason for you to be a lifetime beneficiary of your deceased spouse’s trust any longer; and, in fact, it may be more beneficial to terminate the trust (if at all possible).
The following hypothetical situation explains this concept. Assume your spouse died 4 years ago. In life, he established a revocable trust naming you as the lifetime beneficiary. He died with approximately $500,000 in trust assets (held in a brokerage account), all of which were funded to the Family Trust; nothing is held in the Marital Trust. The Family Trust gives the trustee the discretion to distribute income and/or principal to you for health, education, support and maintenance during your lifetime, and upon your death, the balance will be distributed to your 3 children in equal shares. Currently, the brokerage account has grown in value to over $600,000. Hopefully, the trustee is exercising discretion to distribute the net income out to you each year so that the income tax owed is based on your income tax bracket as opposed to the trust’s income tax bracket. This alone would save thousands of dollars long-term. But another issue that needs to be considered is capital gains taxes. The assets in the Family Trust do not gain a step up in basis upon your death. When they are eventually sold, there will be capital gains taxes owed on the growth in value since your spouse’s death, which amounts to more than $100,000. However, if the trust’s terms allow the trustee to terminate the trust or distribute all of the principal to you, even to the extent of exhausting the trust, this would allow you to transfer the brokerage account – in kind – to yourself or your trust (thus incurring no capital gains). At your death, the assets would gain a step up in basis and your children would escape the capital gains tax that would’ve been paid if they had remained in your spouse’s Family Trust. This could amount to a significant amount of savings in many circumstances. In one particular situation, similar to the above, our client’s family has saved approximately $80,000 in capital gains taxes simply by having our client request a full distribution of the trust’s assets, in kind, pursuant to the terms of the trust.
A simple review of the terms of your deceased spouse’s trust and the trust’s current assets may reveal that you are the perfect candidate for this type of savings measure.
If you have and questions or would like additional information tax-planning, contact attorney Melisa M.W. Mysliwiec at firstname.lastname@example.org or 616.301.0800. Melisa works out of Fraser Trebilcock’s Grand Rapids and Lansing offices, focusing her work in the areas of Elder Law and Medicaid planning, estate planning, and trust and estate administration. She was named a “Rising Star” in Michigan by Super Lawyers in 2013, and is an Accredited Attorney by the Department of Veterans Affairs.
This blog post was published on March 27, 2014 in the Ingham County Legal News.