Estate Planning Following the 2017 Tax Act; The “New Normal” Part II

2. Planning for Couples with Estates in Excess of $5.5 Million (Bypass Trust vs. Portability)

Planning for couples whose estate at the first death is likely to exceed $5.5 Million (i.e., greater than the exemption after the $11.2 Million exemption sunsets) should consider whether to use a credit shelter trust for the surviving spouse or rely on portability in order to utilize the estate tax exclusion of both spouses.

After the first death, if the surviving spouse chooses to file an estate tax return for the estate of the deceased spouse, and if the return is timely filed, the surviving spouse will be given the unused estate tax exemption of their spouse (limitations apply). This is known as “portability”.

Because the portability provisions have now been made permanent, married individuals may be more inclined to proceed with fairly simply “all to spouse” planning, relying on portability to take advantage of both spouses’ estate exemptions, rather than using more complicated bypass trust planning (i.e., AB or ABC trusts). Planners know that there are a variety of tax and non-tax advantages of employing bypass trusts at the first spouse’s death (See #1.c., above), but many people may opt for the simpler alternative. If this simpler alternative is chosen, your trust should provide that it is to continue as the revocable trust of the survivor. This “all to spouse” revocable trust may include an option for the survivor to elect to activate a “Bypass” trust if written in the revocable trust, prior to the death of the first to die, with assets he or she selects. Such election must be done in a legally prepared document known as a “disclaimer” within nine months of the death of the first spouse to die.

The “all to spouse” trust with a disclaimer option to a Bypass Trust is probably the most common revocable trust for a married couple. With this arrangement, after the first death, the survivor can choose among: 1) Filing an estate tax return to elect portability; 2) Funding a bypass trust with assets selected by the survivor if a timely “disclaimer” is executed; 3) Do neither (if one exclusion exceeds the combined estate of the couple); or 4) a combination of 1) and 2).

1. Planning For Larger Estates.

Planning for single individuals with estates likely to be in excess of $5.5 Million and couples with estates in excess of $11 Million will in many instances be more complex and require novel planning approaches. The Tax Act doubled the transfer (gift, estate and generation-skipping) tax exemption for an individual from $5.490M to $11.2M but this increase sunsets after 2025. This presents an incredible planning opportunity for many people. The new increased exemption is a “use it or lose it” benefit. The “lose it” is not only the 2025 sunset but could occur if a future administration takes legislative action to change the law before 2026.

Planning for these more wealthy individuals will have to balance competing goals of preserving access to assets transferred, obtaining an income tax basis increase at the second death, and various legal and practical challenges to making lifetime gifts, in order to use the new temporary enhanced exemption.
Planning issues include:

(a) Large gifts combined with sales or other leveraged transactions afford the opportunity of removing huge amounts from the transfer tax base for estate and GST purposes;
(b) Retain low basis assets to receive a basis step-up at the individual’s death;
(c) Concerns over losing a stepped-up basis for gifted assets that are no longer owned by the individual at death.

One factor is an important one to emphasize if it is your intention to take advantage of the (temporarily) increased exemption: a taxpayer with $11 Million may not just use the $5.5 Million increase in the exemption; rather, to use the increase, the taxpayer must use much of the $11Million (e.g., make a gift of property substantially in excess of $5.5 Million before 2026 and not just $5.5 Million). This is because the use of $5.5 Million exemption by gifting before sunset would result in approximately $5.5 Million remaining in an $11 Million estate. If sunset then occurs, the incremental $5.5 Million of new exemption enacted by the Tax Act would disappear leaving no remaining exemption. Thus using more of, if not the entirety of, the exemption is the only way to secure it from the impact of sunset.

For people with very large estates, in excess of the new exemptions, traditional planning strategies for large estates will continue to apply. This includes gifts of discounted interests in entities to newly formed or existing irrevocable trusts to use their enhanced exemptions. The new exemptions may be modest relative to their estates and thus be readily used to include additional gifts while retaining sufficient assets to live more than comfortably.

2. Blended Family Situation.

If assets are left outright to the surviving spouse, the spouse may give or bequeath the assets to persons other than the first decedent-spouse’s descendants (or may favor some over others of those descendants in ways that the decedent-spouse would not have wanted).
Accordingly, in a blended family situation, having the assets pass to a credit shelter trust or to a Marital QTIP Trust after the death of the first spouse may be important to assure that the first decedent-spouse’s descendants are treated fairly.

But which trust should be utilized? A Bypass Trust uses the first to die’s exemption and the QTIP Trust is in the estate of the survivor. The QTIP Trust receives the benefit of a basis step up for appreciated assets at the second death, but the Bypass Trust does not.

If a trust is needed for the surviving spouse at the decedent’s death for non-tax reasons, should it be either to enjoy a step-up at the second death (e.g. a Marital QTIP Trust) or should it be in the form of a bypass trust which does not achieve a step-up at the second death? By adding additional complexity, you can build in flexibility and provide in the revocable trust that the decision as to which trust is used can be made after the first death.