Due to the increased estate and gift tax exemption made permanent by the American Taxpayer Relief Act of 2013 (ATRA), many people put estate planning into place that may no longer be relevant, or worse, may subject them to higher taxes than someone similarly situated who had done no planning at all.
With the unified estate and gift exemption at $5,000,000 ($5,430,000 in 2015) and portability allowing clients to carry forward any remaining estate tax exemption in a deceased spouse’s estate, many taxpayers find themselves well planned for an estate tax they are no longer subject to, while cementing into place state estate tax and capital gains tax issues which they will encounter.
Therefore, it may be worthwhile to identify ways to “unwind” a complex estate plan as much as possible to favor inclusion of assets over exclusion and minimize capital gain and state estate tax posture as much as possible.
Avoid or reverse the discounting of assets: Avoiding valuation discounts for client owned assets, including unwinding or liquidating Family Limited Partnerships or reacquiring FLP interests so as to hold the underlying (and undiscountable) assets rather than the discounted entity.
Cause inclusion of assets in grantor/ settlor’s estate: People who transferred assets to a trust may now wish to have those assets included in their estate. Consider a common method for creating a “grantor” trust by including the ability of the Grantor to “swap” assets in that trust for assets of equivalent value. High growth or low basis assets can be reacquired in this fashion, pulling those assets back into the settlor’s estate.
Cause inclusion in a beneficiary’s estate: People typically pass assets in trust to beneficiaries for both tax and non-tax reasons, e.g., estate and generation skipping taxes versus creditor protection and financial immaturity of a beneficiary. When the potential tax savings outweigh the non-tax reasons for the trust’s existence, it makes some sense to look at trust-held assets and determine how they might be held by the beneficiary outright rather than in trust, for example, decanting a trust into a new trust, granting the beneficiaries a “general power of appointment” over the trust assets, and thus causing inclusion in the beneficiary’s estate.
Change ownership of spousal assets: Dealing with a rich spouse/poor spouse has long been a common planning technique, particularly in separate property states. The increased exemptions under ATRA only make this more valuable. One variation that may be useful is to consider having the spouse with the shorter life expectancy own the appreciated property. At the death of that spouse, those assets would receive a step up in basis and could be sold without incurring gain. For those in community property states, it may be beneficial to partition assets and have the spouse with the longer life expectancy retain loss assets so as to avoid a “step down” to fair market value at the first death.
“Switch off” grantor trust status: Grantor trusts require that the grantor pay the trust’s income taxes, because the trust’s assets are deemed to be owned by the grantor. Because of ATRA’s increased income tax rates, switching off grantor trust status may lower a family’s overall income tax burden in some instances. Additionally, the grantor, relieved of the burden of paying the trust’s income taxes, may retain more personal assets and invest in items which would receive a step up in basis at death. For grantors who have a “swap power” over trust assets (as mentioned previously), releasing that power may be all that is required.
None of these ideas to unwind an obsolete estate plan are generic; they should be undertaken only with the advice and guidance of qualified legal and tax professionals. This article provides a few possible options and is not intended to be an exhaustive overview of options or solutions. Each of the techniques above may implicate not only estate and gift tax issues, but also income tax, fiduciary duty obligations, and the individual's estate planning documents, not to mention the various intricacies of state law with respect to any course of action.