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Tips From the Pros: The “Hook” of Increased Income Tax Basis

Turney P. Berry describes a potentially promising transaction that’s been made possible by the enormous increase in transfer tax exemptions.

Is $11 million different from $5.5 million, or just twice as much? That’s the question I’ve been contemplating this first quarter after the Tax Cuts and Jobs Act of 2017 doubled our exemption, or “basic exclusion amount,” if you prefer the technical name. My early conclusion is that an $11.18 million exemption, and rising, isn’t just twice as much but in fact is so different that it may usher in what I might hope will be called a “Golden Age” for estate planning. Let me explain, and you can decide if I’m overly optimistic.

Rick Hall was a famous record producer in Muscle Shoals, Ala., whose mentoring of singers and songwriters included the gem that popular songs needed a hook. One of those singer-songwriters was Mac Davis, who decided to adopt that advice literally and in 1972 recorded his hit, “Baby Don’t Get Hooked On Me.”

Estate planners need hooks too. Sure, we know that the plans we prepare and help implement will minimize administrative costs at death; prevent, at least much of the time, family fights; protect assets from the sorts of folks we call creditors and predators; and enable families to take care of minors, those with special needs and those with difficult, perhaps intractable, personal problems. We understand that these estate-planning benefits have nothing to do with taxes. But, do our clients?

Increase Basis

The $11.18 million dollar gift and estate tax exemption offers a hook: an increased income tax basis. To proceed, we need three things. First, we need a client who has less than the estate tax-exempt amount and whose assets are unlikely to exceed that amount at death. Second, we want that client to have some appreciated assets. Third, we want that client to have a family member who also has less than the estate tax-exempt amount and who’s likely to die before our client. When we have all three of these conditions, we have a good reason to engage the client in a conversation about a transaction to increase the client’s basis.

What might such a transaction look like? Suppose the client creates a trust for the benefit of the client’s spouse and descendants and gives the appreciated assets to the trust. The client could even be the trustee. We first note that the client has made a gift. That’s right. In a world of $11+ million gift and estate tax exemptions we won’t need to worry about that gift in many, many instances. We can tell the client, “yes you’re making a gift,” and “no, we need not care.”

Testamentary GPOA

The trust would give the older or sicker family member a testamentary general power of appointment (GPOA), One way to describe that GPOA is as a “circumscribed testamentary general power”—that name is another hook! Such a GPOA would have four characteristics. First, it’s exercisable by the powerholder’s will only in favor of the creditors of the powerholder’s estate. Second, a non-adverse person (someone who won’t benefit if the GPOA goes unexercised) must consent to the exercise for it to be effective. Third, the maximum amount subject to the GPOA is an amount which, when added to the powerholder’s other assets, is a little bit less than the amount of the basic exclusion amount or applicable exclusion amount (depending on the circumstances). And fourth, the GPOA would only extend to assets that have a fair market value in excess of income tax basis.

When the powerholder dies, the assets in the trust will be included in the powerholder’s estate, but not to the extent doing so would cause the powerholder to file an estate tax return. Further, if the assets in the trust consist of some assets that are appreciated and others that, by the time of the powerholder’s death, aren’t, then there’s no step-down in basis for those depreciated assets.

Now’s the time to reiterate that I’m describing a transaction that’s a hook, something interesting and attractive to potential clients that will inspire them to get on with their planning. In many instances, the hook will turn into something that the client actually wants to do. But, not always.  

When Not to Use It

No matter how circumscribed the general power is, prudence suggests that we wouldn’t give it to an elderly person who really dislikes our client! New basis isn’t worth the risk of diverted assets even if we can’t imagine how they could be diverted. Similarly, we wouldn’t give even a circumscribed testamentary GPOA to an individual who has real or reasonably foreseeable creditor problems. Many states protect the assets subject to a testamentary GPOA from the reach of creditors, but if a family joke is that mom keeps running into things with her car but hasn’t hurt anyone yet, then prudence suggests caution, lest a common law court decides that injured plaintiffs ought recover regardless of legal niceties. Even if the family situation is agreeable, the client may live in a state that has its own inheritance tax that affects the effectiveness of this planning, or the potential powerholder may be subject to tax laws that would negatively affect the transaction.

In short, this transaction isn’t for everyone but, then again, can we say that any estate-planning idea is right for absolutely everyone? Of course not. Many practitioners have variations on this basic theme, and more complicated transactions can move assets up to an older generation without the client making a gift. Those ideas have been discussed and will be again, of course.

The purpose of this article is to argue that a potential basis increase appeals to almost every client, whether or not such a transaction turns out to be possible or desirable in the client’s particular situation. I believe we have a new hook that’s been made possible by the enormous increase in transfer tax exemptions since 2012 and particularly starting Jan. 1, 2018. Bait your hook and get out there. Your clients deserve the opportunity for new basis. 

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