Recent income and estate tax changes affect your estate plan and living trust. The basic exclusion amount (BEA) or credit for estate tax purposes is now $5.34 million. The estate tax rate is now 40%. Income tax rates are higher and more complicated with seven different brackets up to 39.6% (51.3% with the highest California tax rates).
The highest income tax rates equal and even exceed the estate tax rate. Traditionally, estate planners are focused on reducing the size of the estate for estate tax purposes with less or little regard for the income tax consequences. Now, the income tax issues are as important as the estate tax issues. Note that the estate tax is only applicable to the top 1% of our tax payers. The income tax applies to all of us.
The AB Trust format was perhaps the easiest and most common way to minimize estate tax for a married couple. An AB Trust allocates a portion of the estate to a "B" Trust to minimize estate tax. A "formula" approach operates like a light switch transferring a preset portion of the estate to the B Trust on the first spouse's death. Often, the formula provides for the deceased spouse's one-half of the community property and all of the deceased spouse's community property to be allocated to the B Trust. The problem is that the surviving spouse has limited access to the B Trust principal. The surviving spouse cannot change the terms of the B Trust. The accounting rules of the B Trust may cause capital gains to be taxed at the higher trust rates. The kids will not be happy to learn that they do not usually get a step-up in income tax basis in the assets inherited through the "B" Trust. These harsh, negative results can occur even if there is no estate tax savings. Any formula approach to funding the B Trust should be examined very carefully. You should control your Trust and not let the Trust control you. A flexible AB Trust should be reviewed to ensure you will have full access to the entire trust estate in the event of a death.
If you have a trust that utilizes an AB format, that trust should be reviewed to be sure that the trust is really consistent with your wishes. Call our office for a free review of your trust.