For the second consecutive year, basis is the belle of the ball at the Heckerling Institute on Estate Planning in Orlando, as due to the increased exemptions in the 2017 Tax Act, many practitioners have become income tax planners rather than estate tax planners.
During their opening session, Lester B. Law, a member of Franklin Karibjanian & Law PLLC in Naples, Fla., and Howard M. Zaritsky, a nationally recognized estate-planning expert in Rapidan, Va., laid out some of the issues inherent in basis planning under the new paradigm and highlighted some trust planning techniques of which basis-savvy advisors should be aware.
Tax Basis Revocable Trusts and JESTs
There are two strategies to consider to double the basis increase—a tax basis revocable trust and a joint estate step-up trust (JEST). These strategies are important because the IRS has stated that the mere fact that property is subject to a deceased spouse’s GPOA doesn’t mean it will receive a basis step-up; Section 1014 will avoid such a step-up if the surviving spouse who gave the POA had the right to revoke the transfers during the year prior to the first deceased spouse’s death.
A JEST is a joint revocable trust created by a married couple who lives in a non-community property jurisdiction. A spouse can terminate the trust while both spouses are alive, and the JEST becomes irrevocable when one spouse dies. This strategy has an advantage over a tax-basis revocable trust because the assets that the surviving spouse contribute don’t pass back to the surviving spouse at the first spouse’s death. This makes Section 1014 difficult to apply.
A step-up grantor retained income trust (SUGRIT) is a worthwhile strategy to consider for clients not subject to the estate tax due to the large exclusion. This is an “income tax play”—but your clients will still have to file gift tax returns.
A SUGRIT is an irrevocable trust created by a donor-spouse, which provides a reserved income interest for a certain period of time up until the first spouse’s death. If the donor-spouse dies first, the assets pass to the surviving donee-spouse. If the donee-spouse dies first, her will leaves the interest in the trust or in trust for the surviving donor-spouse. In essence, the assets pass from one spouse to another and assures a full basis adjustment up to the fair market value of the assets at the first spouse’s death—no matter who dies first.
For clients with whom income tax is their primary objective, consider a variation of this strategy known as a tangibles SUGRIT. The tangibles SUGRIT is an irrevocable trust that holds only non-depreciable tangible property (artwork, antiques, jewelry, undeveloped land), and the gift of the remainder interest shouldn’t be a taxable gift.
Under community property laws, property acquired by a married couple during marriage is owned in equal shares by each spouse. Community property is important because since 1948, a surviving spouse’s one-half share of property held by the decedent and the surviving spouse is considered to have been passed from the decedent to the surviving spouse for purposes of basis—even though that property isn’t included in the decedent’s gross estate for federal estate tax purposes. That is, when the first spouse dies, all the community property gets a full basis step-up on both sides (decedent’s half and surviving spouse’s half).
Three states—Alaska, South Dakota and Tennessee—have enacted community property statutes whereby a married couple can opt-in to have some or all of the property acquired during a marriage become community property. Holding property as community property is a huge advantage, according to Howard and Lester, and, in terms of bringing community property into a non-community property state, the “default setting should be that you want to keep it community property.” This isn’t always easy to do, and you need to keep such property separate.
Community property trusts in Alaska, South Dakota and Tennessee haven’t been tested by the courts, but Lester and Howard note that they should work well under existing law in Alaska. There’s also a good legal argument for community property trusts working well in South Dakota and Tennessee, so they’re worth suggesting until courts rule otherwise.
For the right client, these trusts are the right technique to use. The “right client” could include one with a stable marriage and highly appreciable assets. It’s relatively easy in Alaska, South Dakota and Tennessee for a trust to adopt any of those states as its situs. However, you should urge your client to do more than the minimum that’s required to create an Alaska, South Dakota or Tennessee community property trust. For example, give the situs trustee actual possession and control over the assets, and the trust governing instrument should state that the situs law applies and prevent the trustee from changing the trust situs until the first spouse dies.