Thanks to generosity of Leimberg Information Services and nationally renowned estate planning attorneys, Jonathan G. Blattmachr, J.D., LL.M. (Taxation) & Alan S. Gassman, J.D., LL.M. (Taxation), Florida State Bar Certified Specialist in Wills, Trusts & Estates, we are pleased to provide to you a recently published article on LISI, where they discuss the importance of stepped-up basis planning for married couples. Also, for more information about Alan Gassmans’ JEST Trust Legal Document Form, click here.
Alan Gassman & Jonathan G. Blattmachr: Stepping Up Efforts to Step-Up Basis for Married Couples
The capital gains tax may be the most formidable tax challenge for surviving spouses who need to sell assets to support themselves. The increase in this tax from 15% to 20%, with the additional 3.8% Medicare tax for those with high income in the year of sale makes this a very important topic to cover with clients and their families.
The primary estate planning goal of most married couples is to provide as well as possible for the surviving spouse, but most of them do not recognize that 23.8% of the lifetime appreciation of family investments including in many cases on a large residence will have to be paid to the government in order to produce money for the surviving spouse.
For some survivors, this will be a devastating reality that must be faced when the cost of an adult congregate living facility and proper care is compared to the net proceeds that can be derived from the liquidation of assets. Even a modest investment portfolio owned by a retired married couple can be significantly impacted by these taxes, and the more modest the asset basis, the more crucial it is to protected against lost value due to capital gains taxes.
There are three primary ways that the typical non-community property state couple can attain a full step-up in basis for assets on the first death (understanding that some assets, such as those in pension plans or IRAs never receive a step up when the owner dies):
- Have the assets owned by the first dying spouse more than one (1) year before he or she dies, or if the one (1) year period cannot be met, have the spouse leave the assets to a trust that may benefit the surviving spouse and not trigger the one (1) year rule under Internal Revenue Code Section 1014(e), which denies a step up in basis with respect to assets the spouse dying first received by gift from the survivor within a year of death and that are re-inherited back by the spouse who made the gift. Trying to guess who dies first and even having to talk about this can be a difficult and risky proposition.
- The couple can amend their estate planning documents to either provide that each of them will have a testamentary power of appointment over assets held in on another’s separate revocable trusts or form one joint JEST (Joint Estate Step-up Trust), in which event Private Letter Rulings 200101021, 200210051, and 200403094 and TAM 9308002 support the proposition that assets owned jointly under a JEST Trust or under the revocable trust of a surviving spouse may be considered to have passed through the taxable estate of the first dying spouse, although there are Section 1014(e) one (1) year rule and fundamental issues associated with this (such as whether the private letter rulings and the technical advice memorandum are correct). These issues and possible drafting solutions are discussed at length in LISI Estate Planning Newsletter No. 2086 and the October and November 2013 issues of Estate Planning Magazine that were co-written by Alan S. Gassman, Tom Ellwanger, Christopher J. Denicolo, and Kacie Hohnadell.
This technique has its downsides, as described in the chart below but the JEST Trust itself has no annual cost associated with it unless there are changes in the client’s estate plan. Many clients prefer to have their assets under a single trust created by and for both of them, and preexisting separate trusts can be amended and restated to be considered a part of the single JEST Trust so that re-titling of assets is not required. It will take the planner a few hours to draft and thoroughly review their initial trust draft. See Estate Planning Newsletter No. 2086 for a discussion of some of the provisions Alan Gassman includes in his documents.
- The most reliable way to achieve a full step up on the first death, with potential incidental asset protection features is to establish a conventional Alaska Community Property Trust with an Alaskan Co-Trustee. The Alaskan community property statute was enacted in 1998 to allow both Alaskan couples and non-Alaskan couples to form trusts there to comply with Internal Revenue Code Section 1014(b)(6), which provides that community property will receive a full step up on the death of one spouse. This technique has been endorsed by not only Jonathan Blattmachr, who originated the concept, but also by Howard Zartisky and a number of other well respected experts. It is essentially a joint revocable trust which will be used as the principal estate planning document as the spouses die. The Alaska Trust Company provides the trust form to professionals who use these, and an Alaskan lawyer is available to review and approve the trust document for only about $1000.
Assume that a married couple in their late sixties has $500,000 of investments with a cost basis of $100,000, and their home’s worth is $100,000.
If one spouse dies owning one-half (2) of the assets or the assets are jointly owned in a non-community property state and one of them dies, his or her half of the assets will receive an automatic change in income tax basis to its estate tax value (even if no estate tax is due) and the inherent gain in those assets are forgiven. That result is known as the income tax free “step up in basis” at death. But the inherent gain in the survivor’s half of their wealth will not be stepped up. That means then that there is $200,000 worth of untaxed gain that will cost, depending upon several factors including whether the couple lives in a jurisdiction with state and local taxes of, perhaps, over $50,000 in capital gains tax in order to liquidate their wealth to provide cash to support the surviving spouse or to buy into a retirement center unit.
Contrast that couple’s situation with one if they live in a community property state, such as Texas or California. For that couple, all of the inherent gain is “forgiven” when the first spouse dies. Therefore, the survivor would face no capital gains tax in liquidating the couple’s wealth.
A couple with $2,000,000 of assets and a $500,000 home with the same ratios of growth face a much larger tax which could be $450,000 or more. The above assumes that tax rates will not rise and that there will be no state income tax to be paid.
Why do so many planners fail to discuss this with clients, much less put mechanisms in place to assure a complete step-up in basis of all of a couple’s assets on the first death? One reason is that the full impact of the large capital gains tax increase has not yet been felt by many clients. Another is that the complexity of the recent estate tax changes, and especially the attention given to wealthy clients during 2012 to use their large gift and generation-skipping transfer tax exemptions. Now estate planners can get their eyes on the capital gains avoidance ball.
Planners need to become accustomed to stepped-up basis planning being in the forefront of objectives and structuring. The Alaska community property trust is extremely under-utilized, and the JEST trust or stepped-up basis power of appointment arrangements can be considered for those clients who for whatever reason would not prefer to use an Alaska community property trust.
LISI Estate Planning Newsletter #2161 (November 12, 2013) at http://www.LeimbergServices.com Copyright 2013 Leimberg Information Services, Inc. (LISI). Reproduction in ANY Form or Forwarding to ANY Person – Without Express Permission – Prohibited.