As estate planning attorneys, for years we created revocable trusts for clients and generally recommended the use of trusts to hold assets for the further benefit of the surviving spouse as well as children and more remote descendants. However, with recent changes in the federal estate tax law, including an estate tax rate of 40%, a federal exemption to $5,450,000 for 2016 and the addition of portability (the ability to use a deceased spouse's unused federal estate tax exemption), this general rule may no longer always apply.
Funding the Credit Shelter Trust
One of the most common tools used by estate planners is a credit shelter trust. In a credit shelter trust, assets up to the amount that can pass free from the federal estate tax will be held in further trust for the spouse. These assets, while available to care for your spouse, are not included in your spouse's estate and, therefore, avoid estate taxation when the surviving spouse passes. However, because the assets of the credit shelter trust are not included in your spouse's estate, there is no step-up in basis of these assets on the surviving spouse's death. While we still recommend that clients create and fund a revocable trust as a method to minimize or avoid probate, the decisions regarding the trust provisions for a surviving spouse (e.g. distributing the assets outright to your spouse, or holding them in further trust for your spouse) require more examination.
Outright Distributions to Surviving Spouse
Due to the changes in the estate tax laws, increase in the capital gains tax rate and other income tax changes, in many cases the potential income tax is a greater issue than the estate tax. As a result, in some cases it may be beneficial to alter your estate plan to provide for an outright distribution to the surviving spouse while giving your spouse the option to disclaim this distribution. If your spouse disclaims the distribution (i.e. refuses to accept the outright distribution), the disclaimed property would pass to a credit shelter trust for the spouse's benefit.
Implications of Portability
Further, since portability became part of the federal estate tax law, many estate planners have indicated that clients no longer need to equalize their estates or use a credit shelter trust to minimize the estate tax. While this may simplify the estate planning discussion, recent studies have indicated that couples who have a taxable estate are better off continuing to equalize their estates and use credit shelter trusts rather than relying on portability. This is especially true in cases where the clients have property in a state with a death tax.
Controlling Assets During Surviving Spouses Life
The decision to forego a trust for your spouse and rely upon the possible use of a disclaimer also raises a number of other issues. This decision to minimize potential income taxes must be weighed against the loss of control over your assets; this may be especially true in the case of second marriages or in cases where children are those of one spouse but not the other. Consideration must also be given to issues concerning creditors, whether the clients hold property in a state which also assesses a state death tax and whether a surviving spouse may relocate to a state with a death tax to be closer to his or her children.
Although estate planning has never been a "one size fits all" proposition, changes to the estate and income tax laws have often made the estate planning alternatives and decisions more complicated and require that consideration of income tax, estate tax and control issues when designing an estate plan to meet your goals.