The Changing Paradigm of the Estate Planning Fundamentals

Posted: November 1, 2017 | Press

The unification of the gift and estate tax systems occurred in 1976, and since that time estate planning strategies have changed for married couples. Originally, the common plan was to leave everything to the surviving spouse at death. However, with the potential that more estates could be subject to estate taxes and with an ever increasing fear about a survivor re-marrying and giving the deceased’s share of the estate to a new spouse, a predator, or a creditor, new techniques arose.

Unless Congress acts to change the Applicable Exclusions Amount (commonly referred to as the estate tax exemption amount) it is set to increase to $5.6 million per person in 2018. Currently, the House and Senate have competing proposals, which could either result in the doubling of the estate tax exemption or completely repeal it. The estate tax exemption amount is only one factor that affects the changing paradigm of estate plans. As discussed below, income tax liability should be a factor.

Traditionally, ABC trusts were created to allow for more of a married couples’ estate to pass tax free. To illustrate the benefits of an ABC estate plan, assume a California couple has $14.2 million of community property.

ALL TO SPOUSE PLANNING: An estate plan that requires the distribution of the trust estate to the surviving spouse would result in the estate being taxed only once. Depending upon the estate tax exemption amount at the death of the surviving spouse, it may result in increased tax liability to the estate. In our example, if both spouses pass away in 2018, the entire trust is taxed once. Without a portability election, the estate tax would be $3.4 million at the death of the survivor.

ABC TRUST PLANNING: Under the same example, if the couple elects to have an ABC trust plan, the estate tax is $1,200,000. Fundamentally, an ABC Trust requires the splitting of the trust estate into three separate sub-trusts with the following results:


  • A-Trust: Survivor’s Trust The A-Trust is a revocable trust that holds one-half of the community property assets and all of the surviving spouse’s separate property. Under our example, A-Trust would be funded with $7.1 million. The survivor gets all the income and principal without restrictions. The survivor can leave the remainder of the trust estate to whomever the survivor wants at death. At the survivor’s death, the A-Trust assets are subject to the estate tax. If the survivor’s gross estate remains at $7.1 million, the A-Trust’sshare of the estate tax due at the survivor’s death would be $600,000
  • B-Trust: Bypass Trust The B-Trust is irrevocable, meaning the terms of the trust can’t be changed. The B-Trust is sometimes called the bypass trust, residual trust, or the credit shelter trust. Under our example, the B-Trust would receive $5.6 million – equal to the deceased’s estate tax exemption amount. Typically, the trust would name the surviving spouse as the beneficiary for life with the right to receive the income and principal based on a HEMS standard (i.e. health, education, maintenance and support). The B-Trust is not subject to estate tax at the surviving spouse’s death regardless of any appreciation.
  • C-Trust: QTIP Trust The C-Trust is an irrevocable trust, similar to the B-Trust. The C-Trust is often referred to as the “QTIP” trust. The C-Trust would receive $1.5 million of assets based on our example. The C-Trust must require the Trustee to distribute all the income to the surviving spouse annually. The remaining principal of this trust, at the survivor’s death, is included in the gross estate of the surviving spouse. Assuming that at the death of the survivor the C-Trust has assets totaling $1.5 million the estate tax would be $600,000, assuming death in 2018 under current law.

Estate Tax Savings: As illustrated above, by having the ABC Trust in place, it results in an estate tax savings of $2.24 million.

Currently, there is a paradigm shift in estate planning. As illustrated above, traditional planning focused on estate tax. Now, when considering an estate plan, income tax and capital gains implications are also factors to consider when making a decision. Under current law,
when an individual dies the basis of the acquired asset is stepped-up to the date of death value, thus avoiding capital gains when the asset is later sold. Currently, there are differing proposals in the House and Senate which could repeal the step-up in basis rules. This could result in adverse tax consequences, essentially trading estate tax liability for capital gain tax on assets after death.

A couple with an ABC Trust may experience increased income tax liability as a result of this plan. Under our estate example above, at the surviving spouse’s death, the A-Trust and the C-Trust (QTIP) each receive a step-up in basis; but there is no step-up in basis for the

To that end, if the survivor lives for 10 years more and assuming the B-Trust assets double in value, the $5.6 million amount that was initially funded into the B-Trust would be worth $11.2 million. Then, if sold after the death of the surviving spouse the $5.6 million in gains would be subject to capital gains tax. The resulting tax could be as much as $1.96 million at a 33% overall rate. The trade-off, however, is that those B-Trust assets are not subject to estate tax, which if taxed at the current rate of 40% would generate an estate tax of $2.24 million. Thus, there is an overall tax savings of $280,000 by utilizing the B-Trust.

Only 0.20% of US citizens or residents who died in 2016 paid estate taxes. That means 99.8% who died did not need a B-Trust to save estate taxes. However, that doesn’t mean the risk of predators or creditors subsides. At Ferruzzo, we develop plans to reduce concerns
arising from creditors, predators, and surviving spouse’s remarriages. Depending upon your assets and beneficiaries, we draft plans that utilize only the A-Trust and C-Trust. This allows certainty regarding beneficiaries upon the first spouse’s death, while still receiving the stepup in basis under current law.

Even though the estate tax future is uncertain, it is important that your estate plan is certain. Some believe that postponing planning until Congress acts is better because they will have certainty about the estate tax amount. There is one thing that Congress has taught us in
estate planning historically: the exemption amount may be increased, decreased, or be repealed. However, it will not be stagnant. The changes to the estate tax exemption amount should not stop you from creating or updating any existing estate plan. It is important that you
protect your estate and your beneficiaries by having a comprehensive estate plan.

James K. Leese

James K. Leese, Esq. is a Partner and chairs the Firm’s Estate Planning Practice Group.

His practice group dedicates themselves to all aspects of Estate Planning including Advanced Estate Planning, and Business Succession planning.

Mr. Leese may be reached by phone at (949) 608-6900 or email