1. INTRODUCING THE NEW ERA OF ADMINISTRATION OF TRUST OWNED LIFE INSURANCE
Life Insurance owned by an insurance trust is a universally accepted and widely utilized estate planning tool. Life insurance is ideally suited for wealth management planning in that it has a unique utility to transfer wealth in a tax preferred, leveraged manner, for financing estate taxes, for setting up a fund for preservation of family assets or as a hedge against risks inherent in certain investments, or to balance an estate between family members.
The Baby Boom Generation is now also on the verge of impacting the life insurance business the way it previously and profoundly influenced the investment business. As Boomers move out of the retirement years and into wealth-transfer years, the population over age 65 will likely double between 2010 and 2030 as a percentage of total population, and they are expected to transfer more wealth than ever before. These demographics point toward the continued need for life insurance, insurance trusts, and life insurance management services.
TRUSTEE FIDUCIARY DUTIES
As a practical matter, many individuals who establish life insurance trusts manage their trusts themselves, with the trustee acting as an accommodation to the insured often with minimal participation. The required functions, however, are seldom being performed. Trustees are held to a high fiduciary standard in the exercise of their duties to manage and invest trust assets. A trustee can be held personally responsible for failure to properly administer the trust and for underperformance of trust investments. As a result, trustees should be legitimately concerned with the appropriate management of life insurance policies owned by the trust. And those who establish insurance trusts should be concerned with the exposure that the trustee has invited. Many fiduciaries are under the false assumption that the life insurance agent of record, attorney, or CPA will monitor policy performance. Professional resources, however, have not been up to the job of managing life insurance and the maintenance of insurance trusts. Yet with increased IRS scrutiny, increased litigation and the worse recession since the great depression, the function to be performed by the trustee in monitoring and maintaining the plan has become increasingly important.
ESTATE TAX BENEFIT
In order to enjoy the estate tax saving benefit of a life insurance trust, the trustee must ensure compliance with certain protocols, which include: a validly created insurance trust, contributions to the trust by the insured, payment of insurance proceeds by the trustee, and, of course, all of our favorite … “Crummey” letters. The IRS has recently hired over six new estate tax attorneys, ie auditors, in the San Francisco region and has adopted a more enthusiastic approach to estate and gift reviews. The failure to comply with the required procedures could result in a loss of the ability to make tax free gifts using the annual exclusion which would necessitate the use and therefore reduction of the grantor’s applicable exclusion, or, even worse, could result in the inclusion of the policy proceeds in the estate of the insured upon death.
Trust litigation where a disgruntled beneficiary sues a trustee for violating his or her strict fiduciary duties has become a major growth industry and trust owned life insurance an immense target. Trust litigators often describe TOLI litigation as “low hanging fruit” because trust files are either empty or “papered” with meaningless analysis that is likely to document imprudent decisions. Subsequent trustee depositions can effectively identify the disconnect between well-intended management practices and out-of-date procedures. It is instructive to examine the appropriate steps taken by the trustees and the possible additional actions they could have taken so as to provide a road map for trustees intent on avoiding future lawsuits.
QUESTIONS THE TRUSTEE SHOULD ASK
The trustee concerned with the appropriate management of life insurance policies owned by the trust should ask the following questions:
1. Is the insurance policy consistent with trust objectives?
Should the policy or the schedule of premium payments be adjusted or do the circumstances necessitate policy replacement? Recognize that the burden of proof rests solely with the trustee to justify any replacement recommendation. Because all life insurance products are not created equal, and are, in fact, designed very differently for different portfolio objectives, it is important to first determine the objective of the life insurance portfolio. For example, is the policy a minimum-premium plan intended to finance a defined estate tax liability, or is there an investment objective like “wrapping” life insurance around a defined amount of otherwise taxable investments to shelter gains from income taxes. Portfolio objectives can also change, in which case changes to portfolio holdings may be appropriate.
2. Are scheduled premiums adequate to sustain the policy to contract maturity or insured life expectancy, at a minimum?
This question is answered by periodically obtaining an “in force” illustration and by measuring actual portfolio cash values against cash value targets from the original illustration of hypothetical policy values and considering five activities.
a. Change Premiums: When planned premiums and cash values are more than necessary to cover expected future policy expenses, a policy is considered over-funded, and premiums can be reduced or refunded to the extent of such over-funding. Conversely, when a policy is under-funded, the trustee should consider increasing premiums to thereby increase cash values to cover expected future policy expenses.
b. Change Death Benefits: If a client needs more life insurance, death benefits can generally be increased in over-funded policies without additional premiums, and should therefore be considered (this will generally require additional medical and financial underwriting). On the other hand, the trustee should consider reducing policy benefits in under-funded policies in order to reduce policy expenses to amounts supportable by current annual premium and existing cash values.
c. Change Cash Value Investment Allocations: To the extent that changing the asset allocation for a given policy holding is appropriate, the trustee should re-evaluate the allocation of invested assets underlying policy cash values. This may involve a change of the policy itself, such as to or from a variable product. For example, in under-funded policies, the trustee may consider a more aggressive asset allocation among asset classes with greater historical rates of return to make up for under-funding albeit with greater statistical volatility.
d. Sell, Buy or Exchange Policies: In the same way portfolio managers sell investments that are no longer suitable, the trustee may consider exchanging less suitable life insurance policy holdings in favor of more suitable products that offer rates and terms more consistent with planning objectives. Unwarranted replacement is the exchange of one policy for another without compelling need. This unfortunate situation does not benefit the owner but usually results in a windfall commission to the selling agent.
e. Wait-and-See: If policy cash values are slightly above or below targets, or investment performance is within expected ranges and policy expenses are justified, or if cash values and planned premiums are sufficient to support projected expenses for the foreseeable future, then a deliberate “wait and see” approach can be considered so long as policy holdings continue to be monitored and the client/grantor is kept informed as to these options. About-to-lapse policies tend to be ‘minimum funded’, and require premium adequacy evaluation annually and scheduled premium adjustments periodically.
3. Are the legal protocols in place and followed?
If you have created an insurance trust that owns your policy, in order to ensure that your insurance policy is not taxed in your estate, the trustee should check to ensure that the trust documentation is complete, that the trust is the named owner and beneficiary of the policy, and that the trust maintains a bank account to pay the insurance premiums.
At the time the trust was created, it may have been established that “Crummey” letters are to be produced annually to allow annual exclusion gifts to the trust. The IRS looks at these letters with some scrutiny, therefore it is extremely important that the upkeep of the trust is completed each year, and that the Crummey letters are accurate.
4. Have insurance carrier’s ratings deteriorated?
Although life insurance companies have been less severely affected than the banks and brokerages houses by this economic climate, more frequent checks on insurance company ratings with all the rating services is appropriate.
If a company is downgraded and the client is thinking of replacing his policy with a new policy from another carrier, please review carefully the following “replacement” issues:
• is replacement really in the client’s best interests;
• is the old policy favorably priced and already “paid up;”
• are there significant surrender penalties and/or taxes if the old policy is canceled; and
• is the client insurable at favorable rates.
A decline in ratings can result in reduced policy crediting rates and/or increased policy costs, requiring additional premium for these policies to achieve their acceptance benchmark values.
The economics of a life insurance trust are easy to understand – the return (death benefit proceeds) is known from the time of policy issue and will be paid as long as scheduled premiums are made timely and are adequate to sustain the policy for the insured’s lifetime considering the future and generally increasing policy expenses.
The majority of in-force trust owned policies are managed by non-institutional trustees, however, the litigation and tax considerations are generally the same for non-institutional trustees as for institutional trustees. Without a motivated trustee reviewing the life insurance regularly, the insurance may underperform or even lapse. In addition, failure to make prudent inquiry, appropriate adjustments and to carefully document them has resulted in a proliferation of law suits and allegations of breach of fiduciary duty as well as adverse tax consequences. Antiquated custodial care practices must be abandoned.
The expenditure of time and money to properly maintain your investment will ensure its suitability and enhance its benefits to you and your heirs.
2. SUMMARY OF 2010 TAX RELIEF ACT RELATING TO ESTATE, GIFT, & GENERATION SKIPPING TAX
On December 17, President Obama signed into law the $857.8 billion Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“2010 Tax Relief Act,” or “Act”). The Act makes important changes to the estate, generation-skipping transfer and gift taxes, as well as to the individual and business income taxes.
WEALTH TRANSFER TAX RELIEF
The 2010 Tax Relief Act reunifies the estate and gift tax exemptions for 2011 and 2012, allowing taxpayers to transfer up to $5 million tax-free during life. In addition, it imposes a maximum rate of 35% for all three types of transfer tax. For decedents dying in 2011 and 2012, the Act allows for “portability” between spouses of any unused estate (but not GST) tax exemption. As shown in the chart below, the Act sunsets at the end of 2012, providing a narrow window for use of the enhanced $5 million exemptions and the low 35% rates.
2009 2010 2011-2012 2013
Tax Exemption Rate Exemption Rate Exemption Rate Exemption Rate
Gift $1M 45% $1M 35% $5M** 35% $1M(?) 55%(?)
Estate $3.5M 45% $5M* 35%* $5M** 35% $1M(?) 55%(?)
GST $3.5M 45% $5M 0% $5M** 35% ***$1M(?) 55%(?)
*Executors for 2010 decedents can also elect into the “no estate tax/modified carryover basis” regime.
**Indexed for inflation, beginning in 2012.
***Indexed for inflation.
While the 2010 Tax Relief Act imposes an estate tax on decedents dying in 2011 and 2012 at a rate of 35%, tax will not be due unless the taxable estate exceeds the decedent’s available estate tax exemption. In addition, all appreciated assets transferred at death in those years will receive a step-up in basis. The estates of 2010 decedents are also taxed at a 35% estate tax rate under the Act, with stepped-up basis and a $5 million exemption. Importantly, the Act also provides a special election that allows 2010 decedents to be subject to no estate taxes, with a modified carry-over basis for estate assets.
For individuals seeking to make gifts in excess of the annual gift tax exclusion (which for 2011 remains at $13,000 per person), the 2010 Tax Relief Act afford the opportunity to make aggregate lifetime gifts up to $5 million tax free. The Act reunifies the estate and gift tax systems, allowing full use of the $5 million exemption amount during life without the imposition of gift tax. Thus, for the next two years, reunification gives an unprecedented opportunity for lifetime wealth transfer.
GENERATION-SKIPPING TRANSFER TAX
As for generation-skipping transfers (“GST”), the 2010 Tax Relief Act allows individuals to make aggregate transfers of up to $5 million to “skip persons” outright or in trust tax-free. (“Skip-persons” include family members two or more generations younger than the transferor as well as non-family members more than 37 ½ years younger than the transferor.) Any such transfers made in excess of this $5 million exemption amount will be subject to the 35% GST tax. For generation-skipping transfers in 2010, the Act retroactively imposes a 0% percent tax and a $5 million exemption amount. The $5 million GST exemption amount available through 2012 may be used to exempt gifts to trusts that are expected to benefit multiple generations, so that generation-skipping transfers from the trusts in subsequent years are also exempt from GST.
PORTABILITY OF ESTATE TAX EXEMPTION
The 2010 Tax Relief Act introduces the concept of “portability” of the estate tax exemption at the death of a spouse. Under certain circumstances, the second spouse to die will be allowed to share any unused estate tax exemption of the first spouse to die, providing spouses a combined $10 million exemption from gift and estate taxes, regardless of how their assets are titled.
1. Estate Tax Exclusion Amount Definition Change. The portability concept provides that the estate tax applicable exclusion amount is (1) the “basic exclusion amount” ($5 million, indexed from 2010 beginning in 2012), plus (2) for a surviving spouse, the “deceased spousal unused exclusion amount (“DSUEA”).”
2. Deceased Spousal Unused Exclusion Amount. The “deceased spousal unused exclusion amount” is the lesser of (1) the basic exclusion amount or (2) the basic exclusion amount of the surviving spouse’s last deceased spouse over the combined amount of the deceased spouse’s taxable estate plus adjusted taxable gifts.
The first item limits the unused exclusion to the amount of the basic exclusion amount. Therefore, if the estate tax exclusion amount decreases by the time of the surviving spouse’s death, the lower basic exclusion amount would be the limit on the unused exclusion of the predeceased spouse that could be used by the surviving spouse.
3. Must be Timely Filed Estate Tax Return and Election for Predeceased Spouse’s Estate. The Act continues the position of prior portability bills that the executor of the first spouse’s estate must file an estate tax return on a timely basis and make an election to permit the surviving spouse to utilize the unused exemption. (Therefore, even small estates of married persons must consider whether to file an estate tax return for the first deceased spouse’s estate.)
4. Only Last Deceased Spouse’s Unused Exclusion Amount Applies. Only the most recent deceased spouse’s unused exemption may be used by the surviving spouse.
5. Applies for Gift Tax Purposes. Portability applies for the gift exemption as well as the estate exemption.
(a) There is no concept of “using the first to die’s unused exclusion first.”
(b) There is no way that the Surviving Spouse can utilize her deceased spousal unused exclusion amount without using her own basic exclusion amount.
6. Not Apply for GST Tax Purposes. Portability does not apply to the GST exemption.
7. Effective Date-Decedents Dying After 2010. The provision applies to the estates of decedents dying and gifts made after 2010.
8. Portability Planning Observations.
(a) Heightened Significance in Light of Exemption Amount Increase. Portability takes on increased importance in light of the increase of the exemption amount to $5 million. Marrying a poor dying person to be able to use his or her unused exemption amount (which could be close to the full $5 million) may yield dramatic tax savings.
(b) Impact on Decision to Remarry. Portability may impact the decision of a surviving spouse to remarry. If the new spouse should predecease the surviving spouse the unused exemption of the first deceased spouse would no longer be available to the surviving spouse, and the new spouse may have little or nor unused exemption.
(c) Impact of Decision to Divorce. Portability could even encourage the spouses of wealthy families to divorce, each to remarry poor sickly individuals, and not to remarry after the new poor spouses die. This could make up to an additional $10 million of estate and gift tax exemption available to the family.
(d) Only Available Two Years. Like the rest of the estate and gift tax provisions in TRA 2010, the portability provision expires after 2012. The apparent anticipation is that Congress will extend this benefit following 2012, but there are no guarantees. In light of this, few will be willing to rely on portability and forego using bypass trust planning in the first deceased spouse’s trust. The possible exception would be if the surviving spouse intends to make gifts soon after the first spouse’s death to utilize the unused exclusion – but if the spouse is willing to do that, it would seem better to just use the bypass trust planning in the spouses’ trust.
(e) Reasons for Using Trusts Even With Portability. There are various reasons for continuing to use bypass trusts at the first spouse’s death and not rely on the portability provisions including, (a) the deceased spousal unused exclusion amount is not indexed, (b) the unused exclusion from a particular predeceased spouse will be lost if the surviving spouse remarries and survives his or her next spouse, (c) growth in the assets are not excluded from the gross estate of the surviving spouse unlike the growth in a bypass trust which is excluded, (d) there are other standard benefits of trusts, including asset protection, providing management, and restricting transfers of assets by the surviving spouse. On the other hand, leaving everything to the surviving spouse and relying on portability offers the advantage of a stepped-up basis at the surviving spouse’s death.
Few individual will be willing to rely on portability of the estate tax exemption in planning their estates, because of the fact that portability only exists for two years and because there are a variety of other reasons for continuing to use appropriate “bypass” planning with trusts.
ESTATE PLANNING STRATEGIES GOING FORWARD IN LIGHT OF CHANGED PLANNING PARADIGM UNDER TRA 2010
The $5 million estate and gift exclusion amount (and GST exemption) beginning in 2011 will open up a new paradigm of thinking regarding estate planning and transfer planning strategies. The ability to make transfers of up to $10 million per couple without having to pay gift taxes paves the way for many transfer planning opportunities that, with leveraging strategies, can transfer vast amounts of wealth outside the gross estate. On the other hand, the increased estate exclusion amount may remove the motivation for many clients to do any transfer planning if their estates are lower than that amount.
1. Estate Planning Strategies. Planners will need to apply a triage approach to considering client situations. Taxpayers with estates well over $5 million ($10 million for couples) will probably continue to be interested in sophisticated transfer planning, and to take advantage of what may be just a window of opportunity to do transfer planning with a $5 million gift exclusion and $5 million GST exemption amount.
Married couples with estates approaching $10 million may feel that they no longer have estate tax concerns or need sophisticated estate planning. However, those clients should be cautioned that the $5 million exclusion was very contentious in this Congress and it may not be renewed in two years. Furthermore, future growth in the estate may take the client well above the estate tax threshold amount. These clients will likely be interested in transfer planning strategies.
Couples with estates under $3-5 million or even more may feel comfortable that the combined exclusions of both spouses (perhaps using portability) takes them out of having estate tax concerns, particularly taking into account that the couple may anticipate depleting the estate through living expenses. They may have no interest in any transfer planning at this point. They may even decide to stop making annual exclusion gifts or to drop insurance that was acquired for paying estate taxes. Again, those clients should be cautioned that the $5 million estate exclusion is not permanent.
All married individuals should consider providing flexibility in their trust in order to obtain a step-up in basis for income tax purposes at the second of the couple to die when, as a result of the increase in the estate tax exemption a “bypass” trust is not necessary.
2. Gifts. The ability to move $5 million per individual ($10 million per couple) out of the gross estate opens up the possibility for many individuals to transfer as much as they would want to transfer to their descendants during life without any gift tax concerns.
It is important to keep in mind that the tax advantage of gifts is not to remove the gift assets from the estate, because they are included as adjusted taxable gifts in the estate tax computation. However, there are significant tax advantages of gifts: (1) future appreciation and income from the gift asset is removed from the estate, and (2) fractionalization discounts might be permitted that would not be allowed if the asset were retained until death.
3. Gifts to Grantor Trusts. Making transfers to grantor trusts, where the donor continues to pay income taxes on the trust income, has a huge impact on the amounts that can be transferred over time. The trust assets compound free of income tax, and the payment of income taxes by the donor further depletes his or her estate (substantially over time). Simple $5 million (or $10 million for couples) gifts to grantor trusts can move huge amounts of value out of the donor(s)’ gross estates over time.
The transfer planning opportunities of gifts to grantor trusts can be magnified by leveraging the amounts transferred with sales to the trusts. Huge estate tax savings could result over time from freezing future appreciation from coming into the estate and from “burning” the estate by making the income tax payments. The grantor trust status could be left intact until the grantor had depleted the estate as much as he or she was willing to deplete it.
4. GRATs. GRATs may not be as favored when clients can make gifts of up to $5 million without paying gift taxes and without using sophisticated planning strategies. Sales to a grantor trusts have various advantages over GRATs, including (most importantly) that GST exemption can be allocated to the grantor trust at the outset so that all appreciation in the trust is also GST exempt, but GST exemption cannot be allocated to GRATs until the end of the retained annuity term. Because there will not be as many concerns about making large gifts with the $5 million gift exemption, sales to grantor trusts may take on increased importance over the use of GRATs.
5. Leveraging Transfers Through Valuation Discounts. If the transferred assets are discounted to reflect lack of control or marketability, the value that can be transferred via the $5 million gift exemption is further expanded.
6. Life Insurance Transfers. A limit on the amount of life insurance that can be acquired by an irrevocable life insurance trust is the amount that the insured can give to the trust to make future premium payments. Having $5 million ($10 million per couple) of gift exemptions to cover life insurance premium payments can buy a very large amount of life insurance coverage that can pass free of transfer tax to younger generations.
Split dollar agreements have often been used in the past to help finance the payment of large premiums by an irrevocable life insurance trust where the insured could not make gifts to the trust large enough to cover the premiums without having to pay current gift taxes. If split dollar arrangements have been used in the past, large gifts (within the $5 million gift exclusion amount) could be made to the trust to roll out of the split dollar arrangement and simplify the planning.
Consider making a large gift to the trust currently (while the $5 million gift exclusion still exists), rather than just making increased gifts as premiums become due. Lock in the ability to make a $5 million transfer to pay future premiums without having to pay a current gift tax. There is always the possibility that the gift exclusion returns to $1 million after 2012.
Some clients may be inclined to drop coverage, under the theory that they have no estate tax concerns with a $5 million ($10 million for a couple) exclusion from the estate tax. Those clients should understand that they may not qualify for insurance if they subsequently find they have a need for it. Furthermore, the estate tax system is in a state of flux, and anything could happen in 2013 (including going back to a $1 million exemption/55% tax rate system).
In early 2010, we were concerned that the repeal of the estate tax might dramatically impact how assets pass under formula clauses. The situation may not be as extreme with a $5 million exemption rather than an unlimited exemption, but the dramatic increases in the estate exemption from $3.5 to $5 million may still result in bequests that were never intended nor desired by the testator. This matter was discussed in our 2010 memo entitled “2010 Estate Tax Repeal,” and can be found archived in our website www.ratcliffelaw.info.
CONCLUSION – PLANNING IN AN UNSTABLE SYSTEM.
A $5 million estate exclusion amount means that very few families will pay estate taxes. Planners must keep in mind the myriad
other nontax issues that must be addressed in estate planning. Some of these include asset protection, special needs planning, disability planning, elder financial planning, marital planning, planning for management for beneficiaries, planning for appropriate disposition among beneficiaries, etc. Income tax considerations will take a more prominent role in estate planning as will the need for flexibility in drafting. Individuals may need to have their plans reviewed more frequently due to the dramatic swings in the estate tax laws.
3. 2010 ESTATE TAX REPEAL - a 2010 discussion of the uncertainty of the estate tax laws
Almost all tax experts believed that Congress would pass legislation in 2009 eliminating the one year repeal of the “death tax” (and, more significant for many, the one year repeal of a step-up in basis upon death). Congress did not act, however, leaving us with one of the biggest tax messes in history.
Here is where the situation stands for 2010:
1. Both the estate tax and the generation-skipping transfer tax were repealed at the end of 2009.
2. Both taxes are scheduled to return in 2011 at the unfavorable rates that applied 10 years earlier. The amount that is exempt from each of these taxes will then be $1,000,000 per person, and the tax on the rest will be 55 percent.
3 There is still a gift tax for people who give away more than $1 million during life, but the top tax rate has been reduced from 45 percent to 35 percent, for taxable gifts made in 2010.
4. Heirs can no longer increase the cost basis of inherited assets to reflect the fair market value as of the date of death. Instead, the original cost basis of the property applies. This means that when they sell the assets, there will be capital gains tax on the appreciation. Each estate can exempt $1.3 million of gains from this carryover basis rule. Another $3 million exemption applies to assets inherited from a spouse.
There are four potential scenarios:
1. Repeal stays effective for 2010 and thereafter (extremely unlikely).
2. Repeal stays effective for 2010 and, thereafter, the laws presently scheduled to take effect in 2011 actually do take effect ($1 million exclusion, 55% tax rate and reinstating the step-up in basis).
3. Repeal stays effective for a short initial portion of 2010, but then Congress reinstates the estate tax prospectively using the 2009 rules of a $3.5 million exclusion and 45% rate pending further Congressional action.
4. The estate tax is reinstated retroactive to January 1, 2010, using the 2009 rules.
Most estate planners expect Congress to restore the taxes retroactively. There’s significant support for putting back in place the system that applied in 2009: a $3.5 million exemption for estate tax and generation-skipping transfer tax, with a 45 percent rate for these two taxes as well as the gift tax.
Past court cases suggest that restoring the tax this way is perfect legal. But people with enough at stake may bring lawsuits arguing that a retroactive tax is unconstitutional. Prompt Congressional action would reduce the incentive to bring these cases.
There is a contrarian opinion that Congress will do nothing because estate tax is not high on their list of priorities, especially considering the polarization both parties are exhibiting. This would leave us with the rules before enactment of the 2001 Tax Act ($1 million exclusion and 55% tax rate).
Does the repeal affect you?
For many people, basic estate planning documents will change very little. There are, however, circumstances which existing documentation under repeal may have surprising results. Since bypass and marital trusts (“AB” and “ABC” trusts for married couples) are typically based on formulas tied to the unified credit, repeal of the estate tax could have severe consequences. For example, if your current trust provides for a bypass trust that restricts access by the surviving spouse, and if the balance goes to the surviving spouse without these restrictions, if there is no estate tax everything could go to the bypass trust leaving nothing for the surviving spouse free of restrictions. Or, if the children are to receive an amount equal to the maximum amount that can pass free of estate tax after the first death, and the surviving spouse to receive the balance, the children will, perhaps, receive everything, a result that probably was not intended. If unintended results such as these are possible, it is important to review the terms of your estate plan.
If the entire estate is funded to a bypass trust or to the children as a result of a death during the repeal, in an unintended manner, you may consider amending your revocable trust by preserving the division that would have applied in 2009.
The 2010 law provides that the carryover basis (this is where the recipient of property takes the basis of the prior owner rather than a step up in basis for property received at death) is imposed upon transfers of property at death in excess of $3 million to a surviving spouse and $1.3 million to others. This means that over these amounts, heirs will pay a capital gains tax on the sale of inherited property. The carryover basis at death was considered to be an administrative nightmare when it was enacted as part of the Tax Reform Act of 1976 and was not only repealed in 1980, but repealed retroactively. This new carryover basis is more complicated and has more administrative problems than the 1976 Act so it was felt that it was unlikely to survive. However at least for 2010 it did. This means for example, in the situation described in the preceding paragraph, if the bypass trust or children receives decedent’s property rather than the surviving spouse, the heirs may recognize more capital gains upon sale than under prior law.
If the assets allocated to the spouse are insufficient to take full advantage of the spousal property basis increase because all assets are allocated to the Bypass Trust, you may consider amending your revocable trust to provide that sufficient assets be distributed to the surviving spouse or a qualifying Marital Trust prior to fully funding the Bypass Trust.
What should you do?
Many, if not most, will not be affected by this temporary repeal. Unfortunately, the complexities and cost of determining and addressing the potential effect of this tax mess will deter even those that may be adversely affected. It may be reasonable to defer reviewing your estate plan. After all, you did not create the problem and chances are you will survive the year, so why not wait until there is some tax certainty to deal with the issues and their complexity and cost. In hindsight it may not to be reasonable if the unforeseen happens and your testamentary plan is distorted in an unintended manner. The situation created by Congress is really not a lot of fun, and since there is no clear direction, most will be served best by patiently waiting for Congress to act. The question is whether you are one of the few that will be impacted and whether you should incur attorney’s fees to review your estate plan and deal with the matter now.
If one or both of the examples given above apply to you, you may want an abbreviated modification to your will and trust designed to deal with the unintended result cited above. Alternatively you may consider a complete modification in an attempt to provide a comprehensive approach under two paradigms 1.) death in 2010 and 2.) death thereafter.
If you have not had a review of your estate plan for years, it may be time. You may find that there are other matters that need addressing, and if you are like most, you have forgotten important decisions that you made when the plan was prepared. During this review we can discuss the potential impact of the tax changes. This review is provided at our normal hourly rate and includes a quick look at the documents by us and our checking the current title of real estate; your preparation of a current property list, evidence of ownership of each asset and your checking retirement plan and insurance beneficiary designations; and a meeting of approximately one hour in length to discuss the specifics of your plan..