In our previous discussion of this issue we reviewed why so many estate plans included an A/B (or “spousal” and “family”) trust as a key provision of the plan. It was a way of avoiding high estate taxes on modest sized estates. However, when the tax laws were changed to increase the amount exempt from estate tax to $5.45 million per person (the current amount) it exposed some problems with these plans for people whose estates are under the exemption amount.
- Administrative costs
- Capital gains taxes
Setting up two trusts requires establishing separate banking and investment accounts to hold the assets of each trust.
The surviving spouse may be allowed to use the income and assets in the “family” trust for health, education, maintenance and support but has to be careful that the heirs to the trust do not dispute the manner in which these assets are managed or dispersed. In the case of a blended family, this could cause problems.
Determining which assets go into the “family” and the “spousal” trust often requires the assistance of an attorney, a CPA or a financial advisor.
The income in the “family” trust requires a separate tax return and the tax rates on the two trusts are different.
This means that the surviving spouse may need expensive professional help for the rest of his or her life.
Capital gains taxes:
This can be the biggest issue of all. When someone dies, the assets owned by the decedent have a step-up in cost basis. This means is that if someone bought stock ABC many years ago for $1 per share and dies when the stock is worth $100, the new tax cost basis on ABC is $100. If the heirs sell it for $100 there is no capital gains tax. If it’s left to the spouse the spouse receives the stepped-up cost basis. At the death of the spouse, the heirs receive a second stepped up cost basis.
Only assets left to the surviving spouse or to a “spousal” trust receive a stepped up cost basis at the survivor’s death. Because the assets in the “family” trust never become the assets of the surviving spouse for tax purposes there is no second step-up in cost basis when the survivor dies.
For example, if ABC is put in the “family” trust with a stepped up cost basis of $100 and the stock is worth $200 per share when the surviving spouse dies, the heirs have to pay a capital gains tax of $100 ($200 – $100 = $100) when they sell. If it had been left to the surviving spouse, the capital gain tax would have been avoided.
If the estate plan documents were prepared when the exemption was much lower, the result could be an actual increase in cost and increase in taxes rather than a tax saving. It may be time to meet with your attorney and bring your estate plan up to date.
In our next essay we will briefly look at ways to increase the amount that can be left estate tax free to over $10 million.