On December 22, 2017, President Trump signed H.R. 1, the Tax Cuts and Jobs Act. Part of the law concerns the estate tax exemption limit, which has doubled from $5.6 million to $11.2 million per person. The new estate tax exemption limit is effective until December 31, 2025, after which it will likely decrease to around $6.5 million (unless Congress follows up with more legislation). Notably, the rules involving step-up in basis at death will be unchanged.
Because of these changes, fewer families than ever are subject to federal estate taxes. Also, certain types of trusts that were once-popular estate planning tools may no longer be necessary. These trusts may lead to more capital gains taxes than they would save in estate taxes. These types of trusts include a bypass trust (also often referred to as the “B Trust,” the “credit shelter trust,” the “family trust” or the “non-marital trust”), which is established under a revocable family trust upon the death of the first spouse; a defective grantor trust (“IDGT”); a qualified personal residence trust (“QPRT”); a grantor retained annuity trust (“GRAT”); an irrevocable life insurance trust (“ILIT”) and other such irrevocable trusts that were set up for the purpose of saving estate taxes.
Clients should review whether the tax basis of assets in trust will “step up” at death. Where an asset is transferred into a bypass trust, it only receives a step-up in basis at the first spouse’s death, but does not receive a step-up in basis at the surviving spouse’s death. Likewise, when an asset is transferred into a IDGT, QPRT, GRAT, ILIT, or some other similar estate planning tool, the transferred asset does not receive a step-up in basis upon the grantor’s death. If the asset is subsequently sold by the trust beneficiary after the surviving spouse/grantor dies, the beneficiary will likely have to pay higher capital gains taxes than if he or she had inherited the asset outright – since such trusts do not permit the beneficiary to receive the asset with a stepped-up basis equal to the fair market value at the time of the surviving spouse’s or grantor’s death.
In prior years, such estate planning techniques were widely popular even though they could create eventual capital gains taxes for the trust beneficiaries. However, because the new estate tax exemptions are so high ($11.4 million for individuals and $22.4 million for couples), using such estate planning techniques may no longer provide an estate tax benefit to most people. But they can lead to unnecessary capital gains taxes for trust beneficiaries.
We encourage clients with any kind of a trust to contact us to determine whether the trust still accomplishes its original tax goals.