Certain irrevocable trusts provide a method for excluding certain assets from a decedent’s taxable estate. Trust creators and beneficiaries enjoy estate tax savings through these tools. However, over time both estate tax and income tax rules have changed. Now, beneficiaries of old trusts might face greater capital gains tax requirements while no longer having to worry about estate tax ramifications.
Settlors whose trusts provide for creation of a bypass trust for a surviving spouse might want to review their trust with an estate planning attorney to determine whether this strategy is still optimal given current tax legislation. A bypass trust, also known as a credit shelter trust, is a type of irrevocable trust created upon the settlor’s death which holds certain assets for the benefit of one’s surviving spouse and children; the beneficiaries receive the trust assets estate tax-free. The federal estate tax exemption amount for 2015 is $5.43 million, slated to increase annually with inflation. Married couples also have the option of electing spousal portability, which was not always available in past years when creating bypass trusts was popular.
While bypass trust assets, as well as the appreciation of those assets, is exempt from estate tax, they are not exempt from capital gains tax. In addition, bypass trust beneficiaries do not enjoy a stepped-up basis in the trust assets. If a beneficiary sells assets inherited under a bypass trust, the beneficiary could potentially owe significant income tax on any capital gains upon the sale of an asset.
In addition to legislation changes, a few other items that should trigger review of trust documents include:
- Relocations. Trust documents might need to be modified to meet the requirements under a new governing law.
- Beneficiary life changes. Births or deaths should prompt review of primary and secondary beneficiaries.
- Trust term extension. Some trusts require beneficiaries to take timed distributions. This could create problems if the beneficiary is involved with a divorce or other matters.
- Trustee change. Whether a trustee passes away or fails to satisfy their responsibilities, sometimes a trustee must be replaced. Learn about the benefits of a trust protector and removing a trustee.
Regular estate plan reviews can help to identify and mitigate these risks. As noted above, bypass trusts are irrevocable upon the death of the settlor. Identifying and addressing potential issues and revising one’s estate plan accordingly during one’s lifetime can help to prevent hassle and delay in the administration of the trust for beneficiaries. If one fails to revise documents during one’s lifetime, there are ways to modify irrevocable trusts in certain circumstances. Some states, like North Carolina, have decanting provisions for trusts. In 2015, North Carolina ranks #15 nationally as one of the top places for trust decanting. In fact, the North Carolina Trust Code was modified in August 2015 to provide greater flexibility for trust decanting.
By Attorney Samantha Reichle