Estate planning attorneys have traditionally employed a number of strategies designed to minimize or eliminate estate tax liability for their clients. While many of these strategies increased capital gains tax liability by forfeiting a basis step-up, with federal estate tax rates of up to 40%, capital gains tax was the preferable tax to pay. Changes to the estate tax laws over the past decade, though, have caused estate planners to shift focus from planning to avoid estate tax, to planning to avoid capital gains tax.
For deaths occurring in 2017, both the Maine and federal estate tax exemption amounts have increased to $5,490,000 per person. The federal government has also adopted the added benefit of portability, effectively allowing married couples to have up to $10,980,000 in assets without being subject to federal estate tax. The result of these recent changes is that only about 0.2% of estates are currently subject to federal estate tax. While Maine has not adopted portability, Maine’s estate tax rates (8% – 12%) are significantly lower than the federal rates. In light of the current circumstances, estate plans centered on estate tax avoidance should be reviewed.
For married couples, the most common strategy for avoiding estate tax historically involved creation of a bypass or credit shelter trust to hold the assets of the deceased spouse to fully utilize the estate tax exemption of the first spouse to die. This strategy maximizes the exemption of the first spouse to die and leaves only the surviving spouse’s share of the estate subject to estate tax (and exemption) upon the second death. If the first spouse leaves the entirety of his or her estate outright to the surviving spouse, that amount is included in the estate of the surviving spouse. Such estate inclusion potentially exposes the surviving spouse’s estate to estate tax. Creation of the credit shelter trust utilizes the maximum estate tax exemption in the first spouse’s estate, reducing and often eliminating estate tax in the second estate.
Funding the credit shelter trust at the death of the first spouse provides a cost basis for those assets in the trust as of the date of death of the first spouse. However, because the assets in the credit shelter do not become part of the surviving spouse’s taxable estate, there is no second step-up in basis upon the surviving spouse’s death. The loss of the basis-step-up means that beneficiaries will incur greater capital gains tax if the inherited assets are later sold. Where a 15-20% capital gain tax is preferable to a 40-50% estate tax, in today’s estate tax environment, estate tax is likely no longer a concern, and it may be possible to avoid the capital gain tax through careful planning.
For individuals with existing, unfunded credit shelter trust schemes, estate plans may be simplified to utilize simple wills directing outright distributions, thereby preserving the basis step-up. Even if a credit shelter has already been funded, there may be ways to include the assets in the estate of the surviving spouse. While credit shelter trusts have other benefits that may make their continued use desirable, many individuals may benefit greatly from reviewing and re-thinking their current estate plans.