By Alan Gassman, J.D., LL.M. (Taxation), Florida State Bar Certified Specialist in Wills, Trusts & Estates, AEP (Distinguished), and Christopher J. Denicolo, J.D., LL.M.
Can a married couple in a non-community property state establish a joint revocable trust that will facilitate obtaining a date of death stepped-up basis on the death of the first dying spouse, and the full funding of a credit shelter trust (to the extent of the first dying spouse’s estate tax exemption) that can benefit the surviving spouse and descendants without being subject to federal estate tax on the surviving spouse’s death? After extensively researching these issues and reviewing alternative structures, we have designed a joint trust planning technique, entitled the “Joint Exempt Step-Up Trust (JEST).” The JEST is designed to allow a married couple in a common law state to make maximum use of the first dying spouse’s unused estate tax exemption by fully funding a credit shelter trust upon the first dying spouse’s death, even if this requires using assets contributed by the surviving spouse. We also believe that with proper structuring the joint trust can provide a full step-up in basis for all of the trust assets.
Basic JEST Structure
The basic structure of the JEST involves a married couple funding a joint revocable trust, with each spouse owning a separate share in the trust. Each spouse will have the right to terminate the trust while both are living, in which event the trustee will distribute each spouse’s separate share or portion of each share accordingly. If the spouses already each have separate living trusts, these can be amended to simply become subshare trusts under the JEST. This avoids the need to retitle assets and change beneficiary designations. The JEST becomes irrevocable on the death of the first dying spouse. The first dying spouse will have a general power of appointment over all trust assets in order to have the trust assets considered to be included in his or her estate for estate tax and stepped-up basis purposes. Upon the first death, the assets of the first dying spouse’s share will be applied as follows:
- First, assets equal in value to the first dying spouse’s unused applicable exclusion amount will be used to fund Credit Shelter Trust A for the benefit of the surviving spouse and descendants. These assets will receive a stepped-up basis and will not be included in the surviving spouse’s gross estate upon his or her later death.
- Second, if the first dying spouse’s share exceeds his or her unused estate tax applicable exclusion amount, then the excess will be used to fund QTIP Trust A for the benefit of the surviving spouse and descendants in a manner that will qualify for the federal estate tax marital deduction. The QTIP Trust A assets will receive a stepped up basis, both on the first dying spouse’s death, and again on the surviving spouse’s death. It is important to note that only the surviving spouse can benefit from QTIP Trust A during his or her lifetime.
- If the first dying spouse’s share is less than his or her unused estate tax applicable exclusion amount, then the surviving spouse’s share will be used to fund Credit Shelter Trust B with assets to the extent necessary to utilize the remaining portion of first dying spouse’s unused estate tax applicable exclusion amount. The authors believe that the assets of Credit Shelter Trust B will avoid estate taxation at the surviving spouse’s death, notwithstanding that the surviving spouse originally contributed these assets to the JEST and had the power to take them back up until the time of the first dying spouse’s death, for reasons described below.
- Finally, the remainder of the surviving spouse’s share (if any is left after the complete funding of Credit Shelter Trust B to the extent needed to make full use of the first dying spouse’s estate tax exemption allowance on the first dying spouse’s death) will be used to fund QTIP Trust B, under which the surviving spouse will be at least an income beneficiary. The authors believe that there is a better chance that the assets funding QTIP Trust B will also receive a basis step-up if the surviving spouse retains only the right to receive income.
For an illustration of how this all works, download our JEST Chart.
Concerns and Solutions
There are two primary concerns that arise when dealing with joint trusts in non-community property states: 1) whether, upon the first dying spouse’s death, all joint trust assets (including those contributed by the surviving spouse) can be used to a fund a credit shelter trust for the benefit of the surviving spouse without later being included in the surviving spouse’s estate, and 2) whether, upon the first dying spouse’s death, it is possible to obtain a step-up in basis for all trust assets, no matter which spouse contributed them to the trust. While these concerns are not completely eliminated, the authors have found that many clients prefer to have tax benefits that are not completely certain, so long as there is no material cost or downside to using the structure. On the first spouse’s death, the practitioner and his or her clients can determine how to best proceed with reference to tax reporting, and possibly even obtaining a Private Letter Ruling if the law has not become more clear by that time. There are also possible alternate tax benefits that can apply if the expected tax results are not as designed, as explained below. The JEST is designed not only to derive the benefits of the IRS Technical Advice Memorandum (TAM 9308002) and three Private Letter Rulings (PLRs 200101021, 200210051 and 2004403094), but also to overcome the obstacles against stepped-up basis, and to establish a strong lifetime protective trust system with advantageous back up tax treatment if these four IRS pronouncements are for some reason not applicable. Based on a literal reading of IRC Section 1014(e), the authors also believe that the assets of Credit Shelter Trust B can receive a full stepped-up basis on the first death. To help assure the full stepped-up basis, it is best for the surviving spouse to not be a beneficiary of Credit Shelter Trust B, or perhaps to only be an “addable beneficiary” of Credit Shelter Trust B if certain events occur and it is determined appropriate to do so at the discretion of independent Trust Protectors. For example, the surviving spouse might be added as a beneficiary if and when his or her personal net worth goes below a certain level, or upon the occurrence of other circumstances. The rule in IRC Section 1014(e) should not apply to cause loss of a stepped-up basis where the surviving spouse is not considered to be a recipient of assets that he or she was considered to have gifted to the first dying spouse within one year of the first dying spouse’s death. The JEST technique eliminates many of the concerns that have prevented estate planners in non-community property estates from using joint trusts in the manner approved by the IRS in the PLRs. Although not without uncertainty as to whether both a full stepped-up basis and full funding of a credit shelter trust will occur on the first death, many couples and their descendants will be better off for having used this arrangement for the reasons we have described. While the risks herein described do exist, there is also the risk that the family will ask the planner why these techniques were not used to avoid capital gains taxes and make full use of the first dying spouse’s estate tax exemption amount.
RELATED EDUCATION ON BASIS STEPUP
For more information regarding the JEST, please join us for a special 60-minute teleconference on Wednesday, August 21, 2013 at 9am Pacific (12pm Eastern). For more information and to register, click here.
ABOUT THE AUTHORS
Alan Gassman, J.D., LL.M. (Taxation) is a partner of Gassman Law Associates in Clearwater, Florida. Mr. Gassman is a Florida State Bar Certified Legal Specialist in Wills, Trusts and Estates Law and a member of the National Association of Estate Planners and Councils. Mr. Gassman has authored more than 200 articles in national publications, symposia and law school text books on physician planning, estate tax planning and income tax issues, problems and solutions. He is a contributing author for Leimberg Information Services and the National Association of Estate Planners and Councils. He was also a contributing author for the American Law Institute-American Bar Association Practice Checklist Manual on Advising Business Clients. Mr. Gassman can be reached by phone at (727) 442-1200 or by e-mail at firstname.lastname@example.org.
Christopher J. Denicolo, J.D., LL.M. (Estate Planning), MBA is a partner of Gassman Law Associates in Clearwater, Florida. Mr. Denicolo is a Florida State Bar Certified Legal Specialist in Estate Planning and a member of the Florida State Bar Association and the Clearwater Bar Association. Mr. Denicolo graduated from Florida State University in 2004, he earned both his M.B.A. and J.D. from Stetson University in 2007, and then earned his LL.M. in Estate Planning from University of Miami in 2008. Mr. Denicolor is a contributing author to Leimberg Information Services and for The Florida Bar Journal. Mr. Denicolo can be reached by phone at (727) 442-1200 or by e-mail at email@example.com.