Yesterday’s Planning Upside Down

Now that the federal gift and estate tax exemption is over $11 million per person, I’ve had some clients inquire whether they still need their revocable trusts, or if any adjustments should be made to their trusts.

The short answers are “yes” and “yes”.

Revocable trusts do more than plan for estate taxes. They keep our affairs private both in the event of our incapacity as well as our death. In today’s world of identify theft, that’s more important than ever. Revocable trusts also avoid tedious, time consuming and expensive court processes, such as a guardianship in the case of your incapacity or a probate in the event of your death.

But let’s talk taxes.

For those clients whose estates are larger than the current $11.2 million federal exemption, estate tax planning may still play a role. These clients may have a foundational plan consisting of a revocable trust and related pour over will, durable power of attorney, health care surrogate and living will, among others. Moreover, when one has estate tax issues, advanced planning strategies are often considered.

But what about those of us below the federal exemption? There’s still tax planning involved, but it is income tax planning. There are a variety of issues at play, including maximizing the step-up in tax cost basis that occurs upon someone’s death, the income tax consequences to the beneficiaries of IRAs, 401(k)s, and annuities, as well as the collapsed income tax rate structure for testamentary trusts that continue for our spouse, children, grandchildren or other loved ones.

When the federal estate tax exemption was lower, it was common for married couples to segregate assets into a “husband’s trust” and a “wife’s trust”. Upon the first spouse’s passing, those assets were held in a “Credit Shelter”, “Family” or “Bypass” trust, all of which have the common characteristic of being excluded from the surviving spouse’s estate for federal estate tax purposes.

But for those with estates below the threshold, this planning may no longer be appropriate. Generally speaking, the beneficiaries would like to have a “step up” in tax cost basis not only at the first spouse’s death but also at the second.

Allow me to provide an example. Suppose that Tom and Barbara each have separate revocable trusts, but their combined net worth is lower than the federal estate tax exemption of $11.2 million, and that net worth is unlikely to rise to that level. When Tom dies, the assets in his trust achieve a “step up”. In other words, the assets are re-valued at the fair market value as of Tom’s date of death. Any unrealized capital gains that existed the day before Tom’s death, vanished upon his death. If his trust were to sell all of the assets the day following the death at the then fair market value, the capital gain or loss consequence would only be the difference between the selling price and the date of death value.

If Tom’s trust creates a “Credit Shelter, Bypass or Family” trust for Barbara’s benefit for the rest of her life, he’s used his exemption and the assets will not be taxed in Barbara’s estate when she dies.

But we don’t care if those assets are included in Barbara’s estate because she won’t have an estate tax. In fact, we generally WANT the assets included in her estate so that the ultimate beneficiaries upon Barbara’s death get ANOTHER step up in tax cost basis when Barbara dies, eliminating the unrealized capital gains that have accumulated between Tom’s death and Barbara’s death.

This requires a major transformation to Tom and Barbara’s estate plan. I would venture to say that almost all of the recent estate plans that have come into my office in the last year are set up under the “old” planning technique, and that the beneficiaries to many families could minimize taxes if the Toms and Barbaras of the world would revisit their estate plans with someone who understands these issues.

Space constraints don’t allow me to explore other significant income tax opportunities available under the new law. I’ll review those further in future columns.

Hopefully your takeaway from today’s column is that if you haven’t revisited your estate plan in the last couple of years, it’s probably time to do so.

©2023 Craig R. Hersch. Learn more at

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