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An Evaluation of Estate & Tax Planning Options

It seems that for the foreseeable future, the federal estate tax will continue to affect only the very wealthy Americans. The currently high federal estate tax exemption, coupled with the portability feature, means that for most Americans, the federal estate […]

It seems that for the foreseeable future, the federal estate tax will continue to affect only the very wealthy Americans. The currently high federal estate tax exemption, coupled with the portability feature, means that for most Americans, the federal estate tax is no longer the driver that it had been, which required extensive estate planning. For many people, it may be that a basic trust which simply gives all of one’s property to their surviving spouse, and then passes it all on to their descendants at the death of the surviving spouse, may be all that is needed. This all might suggest that “credit shelter trusts” (also called A/B trusts) and other forms of estate tax planning are needless for many clients except for the very wealthy. However, whether or not the estate may conceivably exceed the various federal estate and gift that limits is not the only consideration in estate planning. There might be other reasons to create additional trusts.

To set the table, current law permits spouses to leave any amount of property to their spouses, if the spouses are U.S. citizens, free of federal estate tax. Further, the estate tax applies only to individual estates valued at more than $5.45 million ($10.90 million for couples). The lifetime gift tax exclusion – the amount you can give away without incurring a tax – is also $5.45 million. But you can still give any number of other people $14,000 each per year without the gifts counting against the lifetime limit and gifts to charities are not taxed.

Further “portability” has simplified estate planning for many small and medium size estates. Falling into the category, “if you can take it with you . . . ” the estate tax exemption is “portable” meaning if the first spouse to die does not use all of his or her $5.45 million exemption, the estate of the surviving spouse may use it. In theory, this doubles the available exemption for a couple at the death of the surviving spouse, assuming the estate assets would have passed tax free to the surviving spouse at the death of the decedent spouse, by means of the “marital deduction” (whereby one spouse may make an unlimited transfer to the other with no tax owed). For example, John dies in 2016 and passes on $3 million. He has no taxable estate and his wife, Mary, can pass on $7.90 million (her own $5.45 million exclusion plus her husband’s unused $2.45 million exclusion) free of federal tax. However, to take advantage of portability, the surviving spouse (Mary in our example) must make an “election” on the decedent spouse’s (John’s) estate tax return.

With the high federal estate tax exemption, coupled with the portability, why complicate the small or medium size estate with more than a simple trust? Consider the case where there are children of a former marriage and/or a chance of remarriage by the surviving spouse. A simple trust which gives all the property and control to the surviving spouse would take away from the deceased spouse any control over whether the assets will be distributed as they wanted – to their own heirs. Here, other trusts may be employed to limit the surviving spouse’s control over what happens to the assets.

A Qualified Terminal Interest Trust (“QTIP”) is generally employed for this. Under this arrangement, the surviving spouse does not obtain the assets directly, but they are held for his/her benefit by a Trustee. There are rules and limitations in the trust about how the assets are to be distributed, which the Trustee must follow. Perhaps the biggest limitation is that the surviving spouse does not have the power to leave the assets to anyone other than the beneficiaries named by both spouses in the Trust. Although in many cases the surviving spouse is the Trustee, they cannot deviate from the requirements of the Trust.

Another type of trust which may be useful is the “Bypass Trust”. This actually removes assets from the estate of the surviving spouse, entirely, while still allowing him/her to obtain interest from the assets until death. With this trust, the property is legally transferred to the children, but in trust, and not actually paid out to them until the death of the surviving spouse. While this type of trust has important application in estates which are above (or are anticipated to grow above) the exemption amount, it also has application in smaller estates.

Using a Bypass Trust can aid in planning for capital gains taxes. Assets allocated to the trust “step-up” in basis upon the death of the first spouse, whereas assets passing to the surviving spouse will only “step up” at the time of her death. This can cut both ways. Where an appreciated asset is to be sold prior to the death of the surviving spouse, it may be advantageous to have a step-up occur at the death of the first spouse, so that the tax hit will be less upon the sale. Conversely, if it is not be sold prior to the survivor’s death, it may be beneficial to wait for the “step up” to occur later, when the asset has appreciated even more (although, the possibility of a “step-down” should not be ignored).

It is often unclear at the time that the estate plan is drafted whether or not a Bypass Trust would be helpful. As a result, many people use a “disclaimer trust”. This basically gives the surviving spouse the ability to decide – at the time her spouse passes away, whether to accept all of the decedent’s property or to “disclaim” (give up) a portion and put it into a Bypass Trust. The advantage is that the status of the estate and need for special planning will be much clearer at the time of the first death, than when the Trust instrument was originally drafted. This flexibility would protect the estate where it has grown more than anticipated, or to determine whether the basis “step up” is more useful than not.

The bottom line is that while changes in the federal estate tax have simplified many aspects of estate planning for most clients, no estate plan should be adopted or continued without a through and specific review of the assets, needs and plans of the individuals involved. Nothing in the law is permanent, nor are the circumstances of our clients’ lives. Clients should be encouraged to review their estate plans every three to five years to ensure that their plans are meeting their needs and ever changing goals.

McCord, Paul

Fraser Trebilcock attorney Paul V. McCord has more than 20 years of tax litigation experience, including serving as a clerk on the U.S. Tax Court and as a judge of the Michigan Tax Tribunal. Paul has represented clients before the IRS, Michigan Department of Treasury, other state revenue departments and local units of government. He can be contacted at 517.377.0861 or