Big Estate Planning Decisions Loom For Some Couples

BIG DECISIONS LOOM FOR SOME MARRIED COUPLES

At first glance, the steadily rising increase in the federal estate tax exemption (currently $5.25 million and predicted to rise to $5.34 million in 2014), coupled with the recent “Portability” election, would seem to guarantee a much simplified mode of estate planning for married couples. In some cases a simple approach is the best approach, but this if far from true for all married couples.

Simple is as Simple Does

Alright, that’s not really the famous Forrest Gump line, but an obvious simple approach for a married couple would be to determine that their estate is less than $5.34 million and therefore revise their trust to operate as a “Simple” Trust instead of the Bypass (AB) or QTIP (ABC) type of trust that they currently have. In a “Simple” Trust, there is no split of the trust estate following the death of the first spouse. Instead, all of the trust assets remain available to the surviving spouse and he/she has the ability to amend or revoke the trust in its entirety. It is that ability to amend or revoke in full that should have some couples, especially those with children from prior marriages wondering if a “Simple” Trust is the best trust for them. The truth is that many times couples do a Bypass or QTIP Trust NOT for tax reasons, but rather for the ability to ensure that when the first spouse dies, the survivor will not be able to shift assets belonging to the deceased spouse away from the intended heirs of the deceased spouse.

Another aspect of the complex trusts (Bypass or QTIP), is that the Bypass and QTIP Trusts (B & C Trusts) are protected from creditors, whereas the surviving spouse’s trust (Survivor’s or “A” Trust) does not enjoy creditor protection. Thus, if a Simple Trust is adopted, the entire estate will continue to be exposed to creditors. This can be a significant lost opportunity to insulate part of the trust estate, especially if the surviving spouse is engaged in “litigation attractive” activities, i.e. a profession such as physician, dentist, lawyer, broker, accountant, restaurateur, landowner, etc.

Understanding Portability

First introduced in 2010, this concept was made permanent in 2013. (You do understand though, that just because the government says something is permanent, it doesn’t mean it’s really permanent. The current administration said the $5 million exemption was “permanent” but it is already $5.25 as this goes to print. Add to that the fact that under President Obama’s proposed budget, he has suggested a $3.5 million exemption, (and he’s the one that gave us the “permanent” $5 million)! That aside, we feel fairly confident about the “permanency” of portability.) Portability allows the surviving spouse to transfer the deceased spouse’s unused estate tax exemption to the surviving spouse. The surviving spouse may then use this deceased spousal unused exemption (DSUE) to make gifts during his or her life or transfer at the surviving spouse’s death. Thus, theoretically a surviving spouse, who elected portability in 2013, who then dies in 2014, would have his/her own $5.34 million plus the DSUE of $5.25 million for a total of $10.59 million to pass to his/her heirs estate tax free, and this could be done with no trust split!! Thus, some couples who have more than $5.25 million, but less than $10.5 million, might consider doing a simple trust and agreeing between themselves that the surviving spouse will elect portability.

Alas, there are potential problems with such a plan. First, surviving spouse might not make the election. After all, it is an election and the survivor might not get around to it (there is a nine month (from date of death) deadline in which to claim portability with the IRS), or survivor might decide that they will spend or gift away the excess funds during their lifetime in an effort to keep their estate below the then prevailing federal estate tax exemption, and then fail to do so.

Electing portability requires the filing of an estate tax return. If done, the statute of limitations on the deceased spouse’s estate remains open until the statute has run on the surviving spouse’s estate. If portability is not elected, the statute of limitations would expire three years after filing of the first spouse’s estate tax return. Thus, if an estate contains difficult to value assets, the ongoing statute of limitations that comes with portability might not be a desirable outcome, and it might be preferable to have a standard AB Trust and file a regular estate tax return on behalf of the deceased spouse without claiming portability.

Another lurking potential problem: Under current law, even if survivor does elect portability, if he or she remarries, they in effect, forfeit the first deceased spouse’s DSUE. Instead, following a remarriage, the surviving spouse may only access the subsequent spouse’s DSUE, (but this assumes that subsequent spouse dies before surviving spouse, which of course, gets tricky)! The result is that the first deceased spouse’s DSUE gets wasted and potentially leaves the surviving spouse with no DSUE.

Last, there are the issues already mentioned above regarding no creditor protection and survivor’s ability to amend/revoke that accompany the use of a Simple trust.

QTIP To The Rescue

A QTIP or AC Trust can be used to solve many of the disadvantages of portability or the use of only a Simple Trust, while still providing some of the benefits of portability. A QTIP trust is split upon the death of the first spouse between a Survivor’s (A) Trust and a QTIP (“C”) Trust. The Survivor’s Trust would be funded with the surviving spouse’s half of the community property and all of his/her separate property. The QTIP Trust would hold all or a portion of the deceased spouse’s half of the community property and the decedent’s separate property. Spouse would be entitled to income (and possibly principal, depending upon the clients’ wishes), from the QTIP for his/her lifetime. When surviving spouse dies, the assets held in the QTIP go to the first deceased spouse’s heirs. This solves the issue of ensuring that the first deceased spouse’s assets do not get shifted to someone else. Further, a QTIP Trust is protected from creditors.

Another advantage of the QTIP Trust is that upon the survivor’s death, the assets held in the QTIP Trust are entitled to a stepped up basis for capital gains tax purposes. This would not be the case if a standard AB (Bypass) Trust is used. In a standard AB Trust, the assets held in the B (Bypass) Trust are stepped up at the first spouse’s death, but are NOT stepped up again when the surviving spouse dies. This can be problematic if the assets held in the B Trust continue (or are anticipated ) to grow substantially over the survivor’s lifetime.

Why Would Anyone Use a Traditional AB (Bypass) or ABC (QTIP) Instead of an AC Trust?

Those couples who will definitely have a taxable estate at the death of the surviving spouse may still want a standard AB or ABC trust so that the assets that are held in the B (Bypass) Trust are not included in the surviving spouse’s estate at his/her death thereby keeping the appreciation on those assets out of the estate for estate tax purposes. (In an AC type Trust, the assets held in the QTIP “C” Trust are included in the surviving spouse’s estate for federal estate tax purposes.)

Couples who are under $10.5 million may still want an AB Trust to ensure (1) that the first deceased spouse’s exemption will be used, and (2) that there will be no shift away from the first deceased spouse’s intended heirs, and (3) there is reason to believe that the assets held in the Bypass Trust may grow substantially over the surviving spouse’s estate thereby keeping that growth out of the survivor’s estate at his/her death.

Is your head spinning yet?

If not, then maybe you missed your calling to be an estate planning attorney. As illustrated above, there are no longer cookie cutter solutions for all couples. Each couple’s situation presents its own issues and these need to be analyzed individually. What will work perfectly for one couple could be disastrous for another couple. We are already starting to see disappointed widows and widowers who are wishing that they had come in earlier to see us as they are either being forced to make trust splits when there is no tax reason to do so, or they have lost out on opportunities to shelter assets either from future taxes or creditors. There is a mistaken belief out there that because the estate tax exemption has risen, that the surviving spouse either doesn’t have to make the trust split, or that they can enter into an agreement with the future beneficiaries of the trust to not make the trust split. These assumptions are false and if wrongly transacted, are fraught with large problems, but that is the subject of another article.

The moral of the story is that married couples with existing estate plans need to see their attorney so that the above strategies can be applied if it makes sense to do so.