It’s a good time to review your revocable living trust

By Bradley Hollister

Contributing Writer

A couple’s revocable living trust can be freely amended during their joint lifetimes. Amendments can be used to adapt to changes in law, family circumstances or the couple’s wishes.

Once the first spouse passes away, however, a revocable living trust usually becomes wholly or partly irrevocable and cannot be easily fixed or modified. Therefore, it must be reviewed frequently and maintained to ensure it achieves its intended purpose.

The American Taxpayer Relief Act of 2012 was enacted in January 2013. The biggest change brought about by the act was an increase in the individual estate tax exemption amount.

While California does not have an estate tax or “death tax,” California residents are subject to federal estate taxes on death for assets above and beyond a threshold amount. This threshold amount is commonly referred to as the individual estate tax exemption amount, or simply the “exemption amount.”

In recent years, the exemption amount has been dramatically increased. In 2005, it was $1.5 million and, in 2008, it was $2 million. The current exemption amount, brought about by the act, is $5.49 million for each individual, adjusted annually for inflation.

Further, any unused estate tax exemption amount by a deceased spouse is “portable” to the surviving spouse, as long as a timely “portability election” is made. Therefore, a surviving spouse may be able to add his or her deceased spouse’s exemption amount to his or her own exemption amount, giving him or her an exemption amount of $10.98 million at death.

As a result of these changes, estate taxes are no longer a concern for most estates, and the complexity of what is called an AB Trust is no longer necessary to avoid them. Also, an AB Trust may carry negative tax consequences.

Prior to 2013, when the estate tax exemption amount was much lower, attorneys wisely advised their clients to execute a certain type of revocable living trust called an “AB Trust.”

Your trust may be unnecessarily complicated.

Under an AB Trust, when the first spouse passes away, the trust property is divided and the survivor’s assets are allocated to a survivor’s trust (the “A” Trust) and the decedent’s assets are allocated to a decedent’s trust (the “B” Trust). The decedent’s trust is irrevocable, and the survivor’s trust is revocable.

Since portability of the deceased spouse’s Exemption Amount was not available, the AB Trust was used to ensure that the couple received “full credit” for the deceased spouse’s exemption amount.

Today, the burdens of the AB Trust may no longer be desirable because of the high Exemption Amount and the benefit of portability under the Act. You may now be able to simplify your revocable living trust by removing unnecessary administrative burden.

Your estate plan also may have negative tax consequences

In California, most community property assets receive a “step up” in tax basis at the death of the first spouse. This means that when a surviving spouse sells an asset, the base value used to determine capital gains tax is the value of the asset on the first spouse’s death, not the date the asset was purchased.

For example, a husband and wife purchase a home for $500,000, and on the husband’s death the home is valued at $750,000. The wife later sells the home for $1 million. She will pay capital gains tax on $250,000 ($1 million minus $750,000).

In comparison, if you have an AB Trust, assets of the first spouse to die (transferred to the decedent’s trust) will not receive this “step up.”

You and your spouse may be able to avoid these administrative burdens and negative tax consequences of an AB Trust by amending and restating your revocable living trust and possibly converting it to a “disclaimer trust.”

A disclaimer trust gives the surviving spouse the option to disclaim assets of the deceased spouse, in which case they would automatically be transferred to a decedent’s trust, or to keep all assets of the deceased spouse, in which case they would be transferred to a survivor’s trust.

In some cases, an AB Trust structure is the best approach. Especially when planning for blended families and when asset protection is desirable.

An AB Trust will ensure one’s spouse does not disinherit children from a prior marriage after the parent’s death. There are a number of reasons why an estate plan might benefit from asset protection, a family history of dementia, business interests with a high degree of liability, or frequent use of caretakers.

If an AB Trust structure is desirable, you should consider using another type of irrevocable trust, a qualified terminable interest property (“QTIP”) trust, rather than a bypass trust.

A key difference between a QTIP trust and a bypass trust is that the QTIP trust is considered part of the surviving spouse’s estate — even though the surviving spouse has limited rights to the assets held by the QTIP trust. Since the QTIP trust is considered part of the surviving spouse’s estate, assets held by the QTIP trust receive a “step-up” in tax basis to fair market value at the surviving spouse’s death.

In conclusion, if your estate plan was prepared before 2013, you should have it reviewed. A simple amendment may help avoid unnecessary administrative burdens and negative tax consequences.

Bradley Hollister is an associate at Rogers, Sheffield & Campbell LLP, a Santa Barbara law firm. 

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