Estate planning has truly evolved over the past 20 years. Gone is the uncertainty about federal estate taxes and the absolute requirement for married couples to use complex trusts to minimize these taxes. But also gone is planning for the “traditional” family. In fact, today’s estate planning is more complicated than ever before.
Estate Planning in 1995 Versus 2015
In 1995 the federal estate tax exemption was only $600,000 and the estate tax rate was 55%. Back then it was easy to accumulate a taxable estate by simply owning a home, a few investments and some life insurance. And while married couples could pass on two times the exemption ($1.2 million) free from estate taxes by incorporating Marital/Family Trusts into their estate plan, these trusts came with strings attached. Yet these inflexible trusts were worth it to avoid the hefty 55% tax.
Today the federal estate tax exemption is a whopping $5.43 million (and will increase annually based on inflation) and the federal estate tax rate has dropped to 40%. In addition, married couples can now combine their estate tax exemptions and pass on two times the threshold ($10.68 million) without Marital/Family Trust planning by making the “portability” election. As a result, the focus of estate planning has shifted away from estate tax planning to more relevant concerns:
- While the federal estate tax rate has decreased from 55% to 40%, since 2012 the top federal income tax rate has increased from 35% to 43.4%, and the top long-term capital gains rate has increased from 15% to 23.8%. This has made minimizing income taxes an integral part of estate planning.
- Today many families are blended, dysfunctional or completely estranged. This has made flexible estate planning and finding ways to modify what was thought to be an irrevocable plan the “new normal.”
Estate Planning for the “New Normal”
Today with the generous and ever-increasing estate tax exemption and “portability” of the exemption available to married couples, it is estimated that 99.8% of Americans will have no federal estate tax exposure. As a result, traditional Marital/Family Trust planning is no longer a necessity for a majority of families. Therefore, instead of planning for excluding assets from the taxable estate, the new trend for couples with less than $10 million is to plan for estate inclusion so that their heirs will receive a basis step up. This can be accomplished by:
- Leaving assets outright to your spouse and making the portability election; but beware if your spouse is a spendthrift, has creditor issues, or if you want to insure your assets stay within your bloodline.
- Taking a wait-and-see approach, such as all to the Family Trust with the ability to disclaim to the Marital Trust or vice versa.
- Including flexibility in the Marital Trust provisions.
- Using a Family Trust and allowing for basis increase through a customized power of appointment.
But while building flexibility into your estate plan is ideal, what happens if your plan becomes irrevocable before you have had a chance to make it flexible? What if it would be advantageous to include assets in the estate of your spouse or a beneficiary, change the situs of your trust or its governing law, add or remove beneficiaries, add a trust protector or advisor, or change the trustee structure? Is it possible to modify or even revoke your inflexible, irrevocable trust? Under many circumstances the answer is yes; these things can be accomplished by agreement or a court order through:
- Reforming the trust: Using judicial interpretation to determine and properly restate your intent.
- Modifying the trust: Changing the terms of the trust to meet your tax‐saving objectives.
- Equitably deviating the trust: Modifying the trust provisions upon the showing of an unforeseen change in circumstance the impact of which would frustrate your intent.
- Invoking the Trust Protector: Allowing a third‐party to exercise specific powers as defined in the trust agreement.
- Decanting the trust: Allowing the trustee to distribute property in further trust for a beneficiary.
Where Should Your Estate Plan Go From Here?
Estate-tax-driven estate plans are becoming a thing of the past. Higher income tax rates, changing state laws, unfavorable jurisdictions and wayward heirs add up to the need for an estate plan that is able to adapt over time. Modern families need modern estate planning solutions, and our firm stands ready to help you create a flexible estate plan.
To comply with the U.S. Treasury regulations, we must inform you that (i) any U.S. federal tax advice contained in this newsletter was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax adviser based on the taxpayer’s particular circumstances.