• Bryan D. Eisenbise, Esq.

Two Recent Developments That Make Reviewing Your Living Trust a Good Idea

Living trusts are designed to withstand the test of time. It is rare for a properly executed trust to not function solely due to outdated terms. Nevertheless, one can take advantage of many opportunities by properly keeping their trust updated. There have been relatively recent changes in both Federal and state law, which have presented two of these opportunities.

The "A/B Trust" is No Longer Relevant

Until 2017, the "A/B Trust" was the structure of choice for a married joint trust. The reason being that an A/B Trust was able to mitigate (or in most cases, eliminate) Estate Tax Exposure. The Estate Tax is a tax on the value of one's estate above an exemption amount; the higher the exemption amount, the less tax one needs to pay (if any, at all). The structure of the A/B Trust effectively doubles the exemption amount as it applies to a married couple. Before 2017 the exemption amount was $5,000,000, before 2009 it was $2,000,000, and before 2003 it was $1,000,000! These historically low exemption amounts made the A/B Trust essential to help the average American family avoid the Estate Tax. At tax rates as high as 55%, almost every married joint trust created before 2017 was an A/B Trust.

Notwithstanding, the exemption has always been unlimited when bequeathing anything to the surviving spouse at the first spouse's death. However, the surviving spouse is then burdened with the cumulative marital estate and only their own single exemption amount to mitigate any tax liability. One of an A/B Trust's defining characteristics is that it splits into two sub-trusts upon the first spouse's death. Half of the estate occupies one of the sub-trusts and is entitled to its own exemption amount. The other sub-trust is a continuation of the family trust for the surviving spouse, who is now only burdened with half of the estate to be addressed by their single exemption amount. With two separate exemption amounts applying to the marital estate,

The A/B Trust's notable disadvantage is that any accumulated capital gain on one of the sub-trusts from the date of death of the first spouse carries over to the beneficiaries, thus exposing them to an immediate tax upon the sale of any inherited assets. (The other sub-trust enjoys all gain being wiped free upon the death of the surviving spouse.) With both sub-trusts accessible by the surviving spouse and the Estate Tax savings nearly always eclipsing Capital Gains Tax savings, the A/B Trust has historically been the standard structure.

What happened in 2017? The Tax Cuts and Jobs Act, which ballooned the then-$5,000,000 Estate Tax exemption to an unprecedented $11,000,000! A post-2017 A/B Trust had the capability of shielding an estate of up to $22,000,000 from Estate Tax liability. With 98.5% of families in the United States having less than a single exemption amount, the two-sub-trust structure of the A/B Trust has essentially become obsolete for nearly the entire country. Although an obsolete A/B Trust poses no inherent threat to one's estate plan, the capital gain carryover to the beneficiaries is an unnecessary price to pay for no additional benefit.

Under the TCJA, our focus shifts from Estate Tax planning to Capital Gains tax planning. In other words, given the inherent lack of Estate Tax risk with the high exemption, what other trust structures can we implement to eliminate the Capital Gains Tax? Although these alternative structures' logistics are beyond this post's scope, a more modern and well-planned trust will shift focus to Capital Gains Tax planning and even provide some additional flexibility to hedge against future tax law changes.

If you created your trust before 2017, reach out to us to review your documents and discuss what options might be right for you. [Bryan@TrustLegalGroup.com or 949-354-2323]

California's Proposition 19 Eliminates the Parent-Child Exclusion from Property Tax Reassessment

Since 1986, Californians have enjoyed the ability to transfer property to their children without property tax reassessment. 2020's Proposition 19 eliminated this benefit unless the property is the parent's primary residence and ends up being the child's primary residence.

Although there is no impact in situations where a child does wish to make a primary residence their own, most often, the child seeks to maintain the property as a rental or a vacation home, both of which would result in reassessment. Unlike the updating of an A/B Trust as outlined above, there aren't too many planning opportunities given this law's fact-specific nature: If a child wants to avoid reassessment, they should consider making the property their principal residence (they have up to one year to move in).

Nevertheless, a parent could consider gifting the property to the child before the law goes into effect. Although this would avoid a property tax reassessment at the parent's death, the same capital gain carryover problem as explained above rears its ugly head in these circumstances as well. Further, putting someone else on the title to your primary residence is an asset protection faux pas.

Parents should also consider updating their estate plan to include language that educates a child on the tax consequences of the property's different potential uses. When there are multiple children, parents can designate the bequest of the family home to whichever child wishes to live there (with other estate equalization strategies providing for the other children). Although there are no clear-cut avoidance strategies without potentially changing the beneficiary's living conditions, more current language can reduce the risk of an unnecessary reassessment.