Here is a situation I experienced with one of my new clients seeking help with an older trust… Does this look like yours?
If I remember correctly, you indicated that your Estate Plan was made 15 years ago. If you have not made any changes to those documents since then, they likely contain what we call an A/B split upon the death of the first settlor/trustor/grantor/spouse.
What the A/B split means is that upon the death of the first spouse, the assets are split between a Survivor’s Trust and a Bypass Trust (sometimes called marital trust or nonmarital trust). Old language like this requires a split of the assets in your trust at the first spouse’s death. Typically the split results in the house (the most significant asset in most trusts) being allocated or split into two pieces on a 50/50 basis. One-piece into the Survivor’s Trust and one piece into the Bypass Trust.
In addition to the added accounting and tax filing obligations, the problem comes when the house is later sold after the passing of the second spouse. That problem is called “capital gains” on the 50% that went into the Bypass trust.
Let me give you an example: on the death of the first spouse (I will use 2020 as an example), 50% of the house stepped up in tax basis to current market value (say $400,000 or 50% is $200,000) and was put in the Bypass Trust with that new basis. The other 50% of the house did not receive a step-up in basis but was put in the Survivor’s Trust at the value of the property when purchased (which could have been 30 years prior).
Thus, when the Surviving Spouse passes (I will use 2030 as an example), the 50% in the Survivor’s Trust steps up to the current market value in 2030 (let’s say $600,000 or $300,000 for the 50% in the Survivor’s Trust). The other 50% that is in the Bypass trust is still valued at $200,000, the value in 2020.
If your kids sell the house in 2030 after the second spouse passes or anytime in between, they incur a capital gains tax on the $100,000 (the difference between 2030 value at $300,000 and the 2020 value at $200,000). The capital gains tax is currently 20% (2020 amount) but has been anywhere between 15% and 35% in the past. Therefore, your kids are faced with paying about $20,000 in taxes (20% of $100,000).
When your trust was written about 15 years ago, that split was mandatory because the estate tax exemption was low, and many people were paying inheritance taxes. To avoid this, the A/B split protected the amount of exemption for the spouse that passed.
Today, the language we use for the split is optional because the inheritance tax is at $11,400,000, much higher and not usually an issue for most people. So you might want to consider making a change to the language in your trust for this new method of distribution on the death of the first spouse.
If this sounds like your situation, you should contact your Estate Planning Attorney to discuss the options for making a change in the distributions.