In this Wealth Planning Update:

  • While trusts do provide estate tax benefits even in light of flexibility in the federal estate tax laws, they also provide many benefits for people who have estates under the taxable threshold.
  • There are many non-tax benefits of trusts that should be considered, including asset protection, marital property protection, and a suitable management structure for inherited assets.
  • Despite the ease of "portability" planning, some trusts may still provide benefits, including (1) shielding appreciation of assets from estate tax and (2) leveraging other exemptions that may not have been actively utilized in a deceased spouse's plan.

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In 2012, there were several tax changes that were made permanent. Included in these changes was "portability" which allows a surviving spouse to utilize any portion of the federal estate tax exemption that a deceased spouse may not have carved out in his or her own estate documents. In light of the portability opportunity and the recent proposal by President Trump to eliminate the estate tax, many people may believe trusts no longer serve a useful purpose in their estate plan. However, for the reasons discussed below, trusts still may play a critical role in taxable estates and those estates under the taxable threshold. 

Non-tax benefits of trusts

Although trusts can appear to be onerous structures only useful for the very wealthy, there are many potential non-tax benefits derived from trusts that should be considered, including:

Asset protection. Concerns regarding asset protection can become an issue if a judgment is issued against someone in a lawsuit. Utilizing a trust is one way to provide a beneficiary with some form of creditor protection for those assets.  For example, assets left outright to a child or spouse can become commingled with his or her own assets, and those assets can be used to satisfy a judgement against that beneficiary. In contrast, assets held in a discretionary trust are much more difficult for a creditor to access to satisfy a claim. 

Marital property protection. Trusts may also be used to protect assets from a beneficiary's future spouse in the event of divorce or death of the beneficiary. Assets held in trust for your spouse can be restricted so that your spouse cannot redirect those assets to a new spouse or children from a new marriage. Trusts for the benefit of your children can be structured so that assets are available for your children's needs, while protecting them in the event of the child's divorce and keeping your children from redirecting the assets away from your grandchildren or further descendants.   

A suitable management structure for inherited assets. Additionally, if there are concerns about a child's or spouse's ability to manage money for his or her benefit, you can name an independent trustee to provide for them or along with them, and you can be specific in how the trust will provide for their needs.  Alternatively, you can instead provide that your child or spouse will act as sole trustee of their own trust. 

Estate tax benefits   

The American Taxpayer Relief Act of 2012 (ATRA) significantly changed the tax planning landscape, particularly for wealthy married couples. The marginal estate and gift tax rate was set at 40 percent while the estate and gift tax exclusions were unified (unified credit) and set at $5 million per individual, indexed for inflation (currently $5.49 million in 2017). The generation-skipping transfer (GST) tax was also affected by the law. This tax subjects an estate to an additional level of estate tax if assets are left to grandchildren or younger generations. ATRA also set the GST tax rate to 40 percent and the GST tax exclusion to $5 million per individual, indexed for inflation (also $5.49 million in 2017). As discussed above, portability was made permanent by ATRA, and allows a surviving spouse to utilize his or her unified credit as well the unused portion of the deceased spouse's unified credit, so long as the appropriate election is made.

Before the enactment of portability, the unified credit was strictly "use it or lose it." Because of this, many estate plans involved the creation of a credit shelter trust that ensured the use of the deceased spouse's unified credit. With the passage of portability, some individuals have foregone the use of credit shelter trusts, instead turning to streamlined portability planning. However, despite the relative ease of portability planning, credit shelter trusts may still serve two important tax planning functions:

  1. Credit shelter trusts shield appreciated assets from further taxation. When a credit shelter trust is funded, not only are those assets shielded from estate tax but the appreciation of those assets may also not be subject to estate taxation. For example, let's assume at the husband's death in 2011 the credit shelter trust is funded with $5 million, representing his unused federal unified credit. When his wife dies 20 years later, the assets in the credit shelter trust are now worth $10 million. The wife also had $5 million in assets held outside the credit shelter trust.

    The $10 million in the credit shelter trust, if administered within certain guidelines, is not subject to federal estate tax at wife's death, and her own unified credit shields the remaining $5 million from federal estate tax in her estate. If portability had been used instead, the wife would have only been able to use her unified credit and her husband's unified credit amount to shelter $10 million of her $15 million estate, resulting in the payment of federal estate taxes at her death. In this scenario, credit shelter trusts worked to help minimize additional federal estate taxes resulting from appreciation.1 Some states also have an estate tax and an associated exemption. Also, credit shelter trust treatment varies from state to state so it's important to consult your advisor about how this may apply to your own unique situation.

  2. Credit shelter trusts can be used to take advantage of GST exemptions. Portability cannot be used for the GST tax exclusion. Therefore reliance on portability may result in loss of the deceased spouse's unused GST tax exemption. If a credit shelter trust is used, the assets placed in the credit shelter trust (and any appreciation on those assets) can be permanently shielded from GST taxation if certain tax elections are made. This can be critical for those couples for whom legacy planning is important.

There are still many benefits to including a trust as part of a comprehensive estate plan. While it is easy to become enamored with the simplicity of certain strategies, planning should still be aligned with a family's goals and objectives. We encourage you to consult with planning professionals when determining which technique is appropriate for you.

Unlike portability planning, a credit shelter trust offers no income tax basis adjustment (for computing capital gains) up to market value at the death of the second spouse. This is an important planning consideration, but it's beyond the scope of this piece. Please consult with your planning professionals regarding this point.