Under the Tax Cuts and Jobs Act (“Act”) that became effective January 1, 2018, a couple can now transfer $11,180,000 each for a total of $22,360,000 until December 31, 2025. Under the old law, if it was effective today, the same couple could have transferred up to $5,460,000 each or a total of $10,920,000 at the end of 2017.
Since 99% of the population is not impacted by the estate tax, the planning now turns toward the discussion of income tax planning for a step up in basis on both deaths. What can you do, if anything, if a parent has already passed and his or her portion of their assets have been transferred to the bypass or credit shelter trust pursuant to the standard A-B trusts used by most families? Without any further planning there will be no step up in basis of the assets inside either a bypass or credit shelter trust. See example below.
This article deals with assets that can receive a step up in basis such as stocks, real estate and other capital assets compared to assets that are in qualified plans or traditional IRAs that was funded on the death of the first spouse. The planning discussed below occurs if the bypass or credit shelter trust gave the surviving spouse a “limited power of appointment.” It also assumes that the surviving parent still needs the income from the bypass or credit shelter trust.
Bypass or Credit Shelter Trusts. Most families are familiar with the typical family trust that provided for the funding of either a bypass or credit shelter trust on the death of the first spouse to die. Any assets funded into the bypass or credit shelter trust would not be subject to estate tax on the death of the surviving spouse.
Let’s say that dad died in 1995. At the time, mom and dad’s joint estate was worth about $1.2 million. If dad left his half to mom, she would have an estate of $1.2 million. When mom died, she would only receive an estate tax exclusion of $600,000. This would expose dad’s $600,000 to the 55% estate tax and the tax bill would have been $330,000.
Now, mom has survived dad by 20 years and still counting. Since then, mom’s assets have grown to $2.4 million and dad’s bypass trust has done the same. The total is $4.8 million. Today, mom’s estate tax exclusion is nearly $11,180,000. My, how times have changed. While unforeseeable in 1995, had dad left to mom his half of their joint estate – even with the subsequent growth – mom’s estate would not be subject to estate tax. One will be quick to say that in either case, neither mom nor dad would be subject to estate tax. So, what’s the point? The answer is income tax.
If mom still wants or needs the money from the bypass trust during her lifetime but would like to have her children receive a stepped up in basis, is there anything that can be done? The answer is yes.
If the bypass or credit shelter trust gave mom a limited power of appointment she can give to her children a general power of appointment that would cause the bypass or credit shelter trust assets to be stepped up in basis on her death. This planning is called a “Delaware Tax Trap” that has been approved by the IRS. The ‘trap” is trigger on the giving of the general power of appointment that is effective on mom’s death.
Other possible planning would be to transfer the bypass or credit trust assets to another jurisdiction that allows for the transfer to a similar type of trust to spring the trap for income tax purposes.