Tax Planning with the Increased Estate Tax Exemption

Attorney Alyssa Graham

June 2015

After a decade of uncertainty regarding the estate and gift tax exemption, we can feel more comfortable planning based on the $5,000,000 estate and gift tax exemption that Congress made permanent* in January of 2013. (The exemption, which is indexed for inflation, is $5,430,000 for 2015). At the same time, Congress made permanent the concept of portability of the exemption between spouses, which means that married couples can share their exemption and pass $10,860,000 to their beneficiaries before any estate or gift tax is due.

The increased exemption means that for many people, estate tax planning is no longer a concern in relation to their estate planning. Therefore, in terms of tax planning a greater emphasis is placed on minimizing long-term capital gains. This is true, especially in states like New Hampshire, where there is no state estate tax. (For states with an estate tax, like Massachusetts, where the estate tax exemption is $1,000,000, state estate tax planning can still play an important role.)

Minimizing long-term capital gains is achieved by taking advantage of the 'œstep-up' in basis for assets you own at the time of your death. This means that the basis of assets (the starting point for calculating gain for capital gain purposes) is increased to the fair market value of the assets on the date of your death. For example, if you bought a vacation home years ago for $100,000 and today it is worth $500,000, if you sell it for $500,000, you would pay capital gains tax on the $400,000 gain you received when the house was sold. If, however, you owned this vacation home at your death and it passed to you children, who then sell it for $500,000 your children would pay no capital gains tax, because their basis for calculating gain would be the fair market value on your death of death, $500,000.

For many years, the traditional wisdom in tax planning for estates was to work to remove assets from a person's estate, so as to avoid the estate tax. Now, with the increased exemption, if the estate tax is not a concern in many cases there is a benefit to having assets in one's estate to obtain the step-up in basis. With the top capital gains rates of 20% (with a potential 3.8% surtax) planning to take advantage of the step-up in basis can equate to significant savings. This has turned some conventional planning techniques on their head.

If you set up trusts when the estate tax exemption was much lower or when uncertainty was still clouding the landscape, it may be a good idea to review your trusts and possibly amend them to take advantage of the changed landscape. Many married couples set up separate trusts designed to allow for the full use of the value of the couple's two federal estate-tax exemptions using what is commonly referred to as credit shelter trusts. This technique was intended to minimize estate taxes, but does not always take full advantage of the potential capital gains saving possible for the couple's beneficiaries. Additionally, credit shelter trusts place restrictions on a surviving spouse's use of assets in the trust, which were necessary to avoid the estate tax, but, again, may no longer be necessary.

Many of our clients in recent years have either been collapsing their two separate trusts into one family trust or amending their separate trusts to provide for what is known as disclaimer planning. These amendments continue to take advantage of the asset management and probate avoidance provided by a trust, but can provide a surviving spouse greater flexibility and take advantage of the potential capital gains saving discussed above.

If you are the primary beneficiary of the credit shelter trust and the combined value of your estate plus the value of the credit shelter trust is less than the estate tax exemption, it may be advisable to collapse the trust. This allows you to do away with the ongoing administration of the trust as well as qualify those assets formerly held in the trust with a step-up in basis when you pass away. This can be accomplished through a Nonjudicial Settlement Agreement, which we recently discussed in our series of articles about modifying irrevocable trusts. For example, consider an individual with a current estate valued at $2,000,000 who is the beneficiary of a deceased spouse's trust, which includes a vacation home with a current fair market value of $1,500,000, which was valued at $700,000 at the deceased spouse's date of death. If this individual collapses the deceased spouse's trust and transfers the vacation home to his or her own trust, when the individual dies, the beneficiaries will get a step-up in basis in the lake house to $1,500,000 and there will be no estate tax because the total estate is $3,500,000, which is less than the estate tax exemption.

If you would like to review your current trusts to see if an amendment is appropriate, or if you would like to discuss collapsing an existing credit shelter trust, please call our office to schedule an appointment with Christine or me. We would be happy to meet with you.

* Congress can act to change the law again, however, unlike before when the uncertainty was written into the law, Congress would need to affirmatively act to change the exemption amount or the concept of portability.