Every year we tend to get a lot of new trust administration clients in November and December. Most people know that if their parent or grandparent had a living trust, they may be able to avoid probate. However, most people don’t know what is involved in a trust administration. We’ve prepared a guide outlining the basic steps to administer a trust.
Estate Tax and Gift Tax
The IRS has released the 2016 estate and gift tax figures. The Estate Tax Applicable Exclusion amount will be $5,450,000 (2015 is $5,430,000). The top Federal Estate Tax Rate remains at 40%. And the Annual Gift Tax Exclusion remains at $14,000.
An estate plan is simply a set of legal documents that instruct your loved ones how to manage your assets when you pass away, and if you have young children, it identifies the persons you want to raise your children. It also authorizes the persons you choose to manage your assets and make health care decisions for you if you become incapacitated. An estate plan can also leverage your assets to reduce or eliminate estate taxes and capital gains taxes, and it can be structured to significantly protect the inheritance you leave your spouse and children from divorce claims and lawsuits.
As you can see, estate planning has to do with death and taxes, and as Ben Franklin said, “in this world nothing can be said to be certain, except death and taxes.” Since everyone will have to deal with death and taxes, everyone needs an estate plan.
The type of estate plan you need will depend on your family, your assets and your goals. At a minimum, you will need a will, which lays out who you want to receive your assets, a durable power of attorney, which names the persons you want to manage your affairs if you become incapacitated and an advance health care directive and HIPAA, which authorize the persons you want to make health care decisions for you if you can’t. If you own a home, you will also want a revocable living trust so your estate won’t have to go through probate.
The 2015 estate and gift tax exemption will be $5,430,000 per person, or $10,860,000 for a married couple. (In 2014, it was $5,340,000 per person.)
You won’t have to worry about an estate tax unless your estate value is greater than $5,430,000 if you are single or $10,860,000 if you are married. The 2015 estate tax rate will stay at 40% for estates in excess of the exemption.
The 2015 annual gift exclusion, the amount you can gift each year to anyone without using any of your lifetime gift exemption, will remain at $14,000 or $28,000 for a married couple.
Because of this big estate and gift tax exemption, almost all families are now exempt from the estate tax. According to the Wall Street Journal, only 3,700 estates will owe federal estate taxes in 2014.
However, that doesn’t mean you don’t need to do tax planning with your estate plan. Many families will still have to deal with the the capital gains tax. Good estate planning can reduce or eliminate the capital gains tax. I wrote about this here and here.
The American Tax Payer Relief Act (ATRA), enacted into law on January 2, 2013, is a game changer for estate planning. The experts are just now sorting out how much of a game changer it really is.
The new law significantly increased the the estate tax exclusion amount. The estate tax exclusion amount is the amount each US person could die with before the 40% estate tax kicks in. During the last decade, the exclusion amount had been as low as $1M and as high as $3.5M. ATRA locks the estate tax exclusion amount at $5M, indexed for inflation, Congress says it’s “permanent.” If true, that’s good news. (But is any tax break really going to be permanent?)
For 2014, the estate tax exclusion amount is $5,340,000. ATRA’s big exclusion amount substantially narrows the number of families that will have to deal with the estate tax. Studies show that under ATRA, only one third of one percent of US families will now be subject to the estate tax.
The result is that for almost all of us, Congress has eliminated the estate tax. (Well, at least until they change the law again.) The game changer is that now the focus of estate planning should be on capital gains tax planning and asset protection, instead of estate tax planning.
Under the old regime, estate planning attorneys focused on eliminating or reducing the estate tax. Estate planning attorneys would include A/B or bypass trust provision in living trusts to capture the estate tax exclusion of the first spouse to die. That same strategy could now result in a big capital gains tax.
Many living trusts were written with a mandatory funding formula – provisions that require the trustee to divide assets into a bypass trust and a survivor’s trust when the first spouse dies (which has been the standard practice). The purpose of the bypass trust was to capture the deceased spouse’s estate tax exclusion amount. The downside was that when the surviving spouse died, the assets in the bypass trust would not get a step-up basis. As a result, when the children sold the bypass trust assets, they would have to pay a capital gains tax. The trade off was to eliminate the estate tax (35%-55%) but pay the capital gains tax (15% fed plus 10% California). Since the estate tax was a bigger tax, it was a good strategy.
But now that Congress has all but eliminated the estate tax, it’s time to focus on the capital gains tax.
Rather than using bypass or A/B trust provisions in your living trust, you should consider amending or restating your living trust to include a disclaimer or QTIP (qualified terminable interest property) funding formula. With disclaimer or QTIP provisions, your children would get a step up in basis when the surviving spouse dies – and if they sold your assets soon after your passing, they would not have to pay the capital gains tax.
Under ATRA, you don’t need a bypass trust to capture the deceased spouse’s estate tax exclusion amount. ATRA includes what is called a “portability” election. If the surviving spouse files an estate tax return (IRS Form 706) for her deceased spouse, then an election can be made on the 706 return to “port over” the deceased spouse’s exclusion amount. The portability election on Form 706 is the method Congress authorized to capture the deceased spouse’s exclusion amount. By filing the 706 and making the portability election, the surviving spouse can add her deceased spouse’s estate tax exclusion amount (at least $5,340,000) to her exclusion amount (at least $5,340,000) for a total estate tax exclusion of over $10,680,000.
Because of the portability option in ATRA, most of us won’t need a bypass or A/B trust. Instead your trust should include disclaimer or QTIP provisions to secure a step-up in basis and eliminate the capital gains tax when the surviving spouse dies.
If your trust has mandatory bypass or A/B provisions, you should review it with your attorney and consider amending it to include a disclaimer or QTIP funding formula.