Building Flexibility into the Estate Plan Formula Clauses: Coming Full Circle
Power of Appointment Credit Shelter Trust – “A Final Bite at the Apple” or “Maybe not Ready for Prime Time.”
With the increase of the applicable exclusion amount to $5.43 million in 2015, and the enactment of portability, on the
surface it appears reasonable to abandon the traditional marital/credit shelter trust design in favor of a portability type
estate plan, which could involve either an outright transfer to the surviving spouse or a QTIP marital trust design as
discussed above. However, each plan has its pros and cons.
Outright Transfer to Surviving Spouse (Tenants by the Entireties):
Where husband and wife hold property as tenants by the entireties, this offers the couple maximum asset protection while both are alive, as well as a second step up in basis at the death of the surviving spouse. The downside to this arrangement is that at the death of the first spouse, all the assets are exposed to the creditors of the surviving spouse, and depending on the size of the combined estates, a “portability election” may still be required to preserve the DSUE amount.
QTIP Marital Trust:
With this approach, at the death of the first spouse, his or her assets pour into a QTIP trust for the benefit of the surviving spouse. The advantage of this arrangement is that assets held in the QTIP trust are exempt from the creditors of the surviving spouse and receive a second step up in basis at the death of the surviving spouse. The disadvantage to this plan is that an estate tax return is required to be filed to make the QTIP election, and like an outright transfer, income is taxed to the surviving spouse.
Credit Shelter Trust:
Although the present sentiment appears to have shifted toward a “portability type plan,” the simplicity and flexibility of the traditional credit shelter trust may still appeal to many couples. With a credit shelter trust:
- There is no need to file an estate tax return if the decedent’s estate does not exceed his or her remaining applicable exclusion amount.
- The surviving spouse may serve as sole trustee or co-trustee.
- Income may be distributed among the spouse and children to reduce current income taxes, as well as future estate taxes at the death of the surviving spouse.
- The original stepped up basis is preserved at the death of the surviving spouse, should the property decrease in value after the death of the first spouse.
- For couples with combined estates close to $10.86 million, any future appreciation of assets held in the credit shelter trust will not be included in the estate of the surviving spouse.
- Assets held in the credit shelter trust are exempt from the creditors of the surviving spouse.
Downside to the Credit Shelter
The main downside to the credit shelter trust is that there is no second step up in basis on appreciated assets at the death of the surviving spouse. This may or may not be of concern to the family, depending on the type of assets placed in the trust and whether they are managed to produce annual income or growth in the portfolio.
Power of Appointment Credit Shelter Trust:
Over the last five years, the higher applicable exclusion amount has significantly decreased the number of taxable estates and increased the number of instances where the value of the surviving spouse’s estate is well below his or her remaining applicable exclusion amount.
In this situation, a number of authors have proposed various alternatives to assure assets held in the credit shelter trust receive a second step up in basis, but not a step down in basis, at the death of the surviving spouse. In effect, it’s the best of all words! Some of the more workable proposals include:
- Giving an independent trustee discretion to distribute assets from the credit shelter trust to the surviving spouse. This approach allows the trustee to distribute appreciated assets to the surviving spouse while retaining depreciated assets in the trust to prevent a step down in basis.
- Giving an independent trustee or trust protector the authority to grant the surviving spouse a general power of appointment over specific appreciated assets held in the trust.(1), (3)
The drawback to these approaches is that the independent trustee may fail to act, the surviving spouse may die unexpectedly, or the surviving spouse may have creditors.
Two of the more problematic approaches include:
- Giving the surviving spouse a contingent general power of appointment.
- Giving the surviving spouse a limited power of appointment over trust assets that the spouse can exercise in such a way as to trigger the Delaware Tax Trap under Section 2041(a)(2) of the Code.
Need more information on building flexibility into your Estate Planning? Whether you are planning for yourself or a family member, The Elder Law Center of Mondschein and Mondschein, P.A. is here for you. Please contact us using this online form here, or call our office at 305.274.0955 to schedule a free phone consultation.
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(1) Edwin P. Morrow, III, The Optimal Basis Increase and Income Tax Efficiency Trust (2013), page 10
(2) Barbara A. Sloan, Spousal Transfers – During Life, at Death and Beyond, Chapter 12, pages
39-63, 47th Annual Heckerling Institute on Estate Planning, January, 2013
(3) Howard M. Zaritsky and Lester Law, Basis-Banal? Basic? Benign? Bewildering?, Fundamentals Program Materials, Chapter 1, pages 75-94, 49th Annual Heckerling Institute on Estate Planning, January, 2015