Recent Changes in Estate Tax Laws May Allow Many Clients to Simplify Their Estate Plans

New Higher Federal Estate Tax Exemptions Plus Exemption Portability.

For many estate planning clients, the estate tax changes enacted by Congress late last year were a defining moment. Not only did a $5 million inflation adjusted gift and estate tax exemption emerge (one which is not scheduled to expire), but the legislation also made permanent a very popular estate tax feature known as estate tax portability.

What this means for clients is that a married couple is unlikely to need a large portion of their current estate plan to avoid estate tax if their combined estates at death are likely to be less than $10 million, and they live in a state that does not impose its own an estate or inheritance tax.

Historical Reasons for “Family Trusts” in Estate Planning.

When federal estate tax exemptions were lower, and each spouse had his or her own exemption, to fully utilize these exceptions many plans created a Family Trust to capture assets equal to the exemption and hold them in trust so that they would not be included in the estate of the survivor. It was a “use it or lose it” system. Without the funding of a Family Trust, the exemption was lost. With the changes in the law, however, the surviving spouse can add any unused exemption of a deceased spouse to his or her own exemption if the survivor files an estate tax return to claim this benefit. The result is that a separate Family Trust is no longer needed to preserve the benefit of a deceased spouse’s estate tax exemption. With very little effort, the surviving spouse has a $10 million combined exemption with an inflation adjustment for the survivor’s one-half. As a result, a good number of estate planning clients whose combined estate will be less than $10 million could eliminate these Family Trust provisions from their estate plan.

Advantages of Eliminating the “Family Trust.”

Eliminating the Family Trust for the estate plan not only makes the plan a bit easier to follow, it also should reduce administration expenses when the first spouse dies. It will no longer be necessary to split assets among a number of trusts. Nor will it be necessary to prepare a separate income tax return for the trust, prepare accountings, and monitor the income tax provision of the trust on an annual basis. Moreover, under the prior approach assets that were held in a Family Trust that appreciated were denied an income tax basis step-up upon the death of the surviving spouse. This loss of step-up could increase income tax payable when such assets are sold. Not having a Family Trust guarantees this basis step-up and produces potential income tax savings. Thus, for many clients, eliminating the Family Trust could pay handsome dividends.

Why Some Clients May Wish to Continue the “Family Trust.”

Are there reasons why, despite the potential gain of simplification that a client may want to continue a Family Trust in their plan? There are several possibilities: (i) If the clients reside in a state that continues to maintain its own estate tax (e.g., Illinois) or estate and inheritance tax (e.g., Iowa), then the clients may need to retain the establishment of the Family Trust at the death of the first spouse as part of their plan in order to preserve the first spouse’s exclusion from the state estate and/or inheritance tax; (ii) if the husband and wife have children from prior marriages and have different plans for disposing of assets upon the death of the survivor, a Family Trust may still make sense; (iii) similarly, if the spouses are concerned that the surviving spouse might remarry and give all the family assets to a second spouse, the Family Trust provides a helpful segregation to protect the assets; (iv) a trust also provides protection against other financial predators who might seek to gain access to financial assets of an older surviving spouse who is not at the peak of his or her financial powers; and (v) of course, if the combined estate of a married couple is likely to exceed $10 million, the Family Trust can still provide substantial estate tax savings under a number of likely scenarios.

What is Right for Your Family?

Like many estate planning decisions, removing or maintaining the Family Trust involves a balancing of positive and negative factors. What is right for one family may not be right for another. Yet there is no doubt that the rules of the game have changed. In the right situation, after careful consideration, the result may be a more efficient, simpler, less expensive to administer estate plan without a Family Trust. If this is something that interests you, contact your Quarles & Brady attorney to discuss it.