Many practitioners have tuned out estate planning because of the high current temporary estate tax exemptions. That’s a mistake because many clients might benefit from getting income tax basis step-ups on assets with planning in the current environment. This is not just planning for super-wealthy clients, but for clients at even lower income and wealth levels. The following checklist reviews several ideas to help maximize basis step-up for clients.
• Current large estate tax exemptions of $11.4 million create significant planning opportunities for practitioners to help clients maximize or increase tax basis that are relevant for most clients especially those with smaller estates below the exemption.
• Getting an adjustment of basis on death of not only the client, but of another elderly family member, can provide significant income tax benefit.
• Client wills need to be planned so that assets for clients under the estate tax threshold are included in the estate and get a basis step-up. Even though practitioners don’t draft wills they should ask clients about this and, if comfortable, look at the client’s will to see what was done.
• Most wills that are more than a few years old likely do not have this type of approach. Many older wills were structured with so-called A-B trusts or a credit shelter trust to use exemption that was outside the client’s estate and a marital trust for any excess to avoid estate tax on the first death.
• So how should a common client estate plan or will be structured to maximize income tax basis in this new tax environment? The simplest approach, which is really no plan and not advisable, is for the client to have a simple will to leave all outright to the surviving spouse. But this leaves all the asset exposed to creditors, etc. Another approach which was common for smaller estates in the past was to leave all assets to a surviving spouse with the right to disclaim into a credit shelter trust for which the surviving spouse is a beneficiary (or the only beneficiary). That is an improvement but there is no basis ste- up on the second death. Another approach is to leave all to a QTIP or marital trust but that does not provide sufficient flexibility but under current law it does provide the benefit of a second basis step-up on the death of the surviving spouse. But perhaps a better approach might be useful as a default for many plans.
• State estate tax still must be considered for many clients and might require a change in the default approach for practitioners in those states.
• Portability provides another option to plan the overall estate.
• Flexibility in planning is critical given the seemingly constant changes in planning. Ideally, if a will could be created to give the option to have the assets included in the estate when the surviving spouse dies, or not depending on the law at that point of time.
• There are a number of ways to create flexibility to cause estate inclusion. Give an independent trustee the right to bust the trust. Give a general power of appointment over the assets. That power can be made contingent on specified factors. Another option is to give an independent party, e.g. a surviving spouse, a general power of appointment over assets. Who will be given this role? Will the CPA be named? What is the risk of making this decision? When will or should this be done? The difficulty is knowing when a client is passing away. What happens if the person to whom the property is distributed to or who is given a general power gives it to a new spouse? What if the person given the property for basis step-up enters a nursing home and the costs deplete all of the assets? Can the general power of appointment be limited only to appreciated assets? Another approach, which is quite complex, is to permit the violation of the Delaware Tax Trap. For this to work you have to be able to extend the rule against perpetuities. If the state law has an unlimited rule against perpetuities this cannot be done unless the situs of the trust is changed to a different state that has a finite rule of perpetuities.
• You could use a QTIP trust and the surviving spouse can benefit. The QTIP could be structured as a so-called “Clayton QTIP” in which case an election to have some or all of the trust is treated as a martial trust which is included in the surviving spouse’s estate for a second basis step-up. If the marital QTIP trust election is not made over all of the trust assets those assets pass to a credit shelter or family trust. The latter will not be included in the surviving spouse’s estate which might be beneficial for a number of reasons. It can benefit people other than the surviving spouse, avoid inclusion in the surviving spouse’s estate if the law changes.
• Practitioners should consider that the law may change in the current environment where Democratic Presidential hopefuls have almost uniformly suggested that wealthy taxpayers are not paying their fair share of tax.
• All advisers should inform the surviving spouse, and to be more cautious, document on the death of a client that they advised the surviving spouse, to file an estate tax return for portability to preserve the Deceased Spouse Unused Exemption (“DSUE”). There might be a remedy for those clients that failed to file. Regulatory relief is available under Code Section 9100. The surviving spouse can request of the IRS a private letter ruling saying that they neglected to file for portability. This is a costly option but may be worthwhile. Rev. Proc. 2017-34 provides relief options for estates under the estate tax exemption, and within two years of death. Must file a return to obtain this relief.
• Some irrevocable trusts give a beneficiary the right to withdraw the greater of 5% of the value of the trust or $5,000. If the value of the trust has appreciated that 5% right can be used to draw out appreciated assets out of a trust into someone’s estate for a basis step-up. This can provide a simple mechanism to pull assets back into the estate. For example, if a practitioner is preparing a Form 1041 for an irrevocable trust, be alert to highly appreciated assets on the trust’s account statement. If there is significant appreciated assets recommend that the client meet their estate planner to determine if there is a so-called 5 and 5 power that might be used to pull those appreciated assets into the estate of an elderly beneficiary who is below the now very high estate tax exemption amount. Code Section 2041(b)(2).
• A client may have made transfers to a trust to benefit family members. If the portfolio assets in the trust have appreciated substantially, can anything be done to increase income tax basis and eliminate the capital gains on those appreciated securities? It may be difficult with the older trust. But if a new trust is being planned, can something be done differently to possibly make it easier to get a basis step-up? Consider adding a parent or other senior family member that has a small estate as a beneficiary and also grant that parent a general power of appointment (GPOA) so that the assets in the trust will be included in her estate. Thus, even if for example, husband created a trust for wife and descendants, the inclusion of an elder parent can eliminate the entirety of the appreciation of the assets in the trust saving substantial capital gains. Key is that this is a basis step-up on the death of the elderly parent, not one that waits until the death of the client or the client’s spouse. Whoever the GPOA holder is should also be a beneficiary of the trust created to avoid an issue analogous to naked Crummey power holders that the courts have ruled against. in Cristofani v. Comm’r, 97 T.C. 74 (1991), acq. in result only 1992-1 C.B. 1.
• Consider planning if a spouse is terminally ill. But be mindful of the rules under Code Section 1014(e). If a transfer is made and the spouse dies in less than one year, there is no basis step-up if the assets are transferred back to the transferor spouse. That will not work under 1014(e). But if instead the assets passed to a typical credit shelter trust that can sprinkle or spray assets and income among the surviving spouse and descendants may not be viewed as a transfer back to the transferor surviving spouse.
• There are many ways listed in Code Section 1014 to gain a step-up in income tax basis. Community property can provide a valuable means of getting a step-up in basis, not just on the half of the assets held by spouse that died, but on all of the marital or community assets. See Code Section 1014(b)(6). While a bit more complex and costlier, clients in non-community property states can create trusts under the laws of Alaska, Tennessee, or South Dakota which have special rules. They can opt into a community property treatment for those assets. For clients with substantially appreciated assets, this can be a creative tool to try to get a basis step up on all of the assets transferred to that trust.
• What if a client cannot prove the actual tax basis of an asset? Can anything be done? The actual rule is if you can provide some information you shift the burden back to the IRS for the IRS to have to present a different basis analysis. IRC Sec. 7491 – you can shift burden to the current rule. It is a “close enough is good enough” rule. Practitioners can help clients estimate or approximate income tax basis. IRS. Cohan v. Comr., 39 F.23 540. • Be certain that you advise clients of the risks and issues attendant to these techniques. You might consider even sending a letter listing some of the issues.
Martin M. Shenkman is the author of 35 books and 700 tax related articles. He has been quoted in The Wall Street Journal, Fortune, and The New York Times. He received his BS from the Wharton School of Pennsylvania, his MBA from the University of Michigan, and his law degree from Fordham University.