Q. My wife and I set up a Living Trust back in 2001, but we have never updated it. In view of the recent change in the tax law, is that something that we should consider?
A. Yes, by all means! At the time you created your trust, the estate tax exemption was only $675,000 per person, and the first spouse’s exemption died with that spouse unless the couple’s trust directed a “trust-split” upon the first death compliant with relevant tax rules.
Under that technique, the deceased spouse’s share would go into an irrevocable Exemption Sub-Trust, and the balance would be allocated into the Survivor’s Sub-Trust. To make this work, the survivor would typically have only restricted access to the funds in the Exemption Sub-Trust. This arrangement would preserve the first spouse’s exemption so that – at the survivor’s later death – the couple’s two exemptions could be combined for use following the death of the survivor, thereby doubling the assets the couple could pass estate tax free to their children or other beneficiaries.
Under former law, this “trust-split” upon the first death was essential to preserving the first spouse’s exemption for later use following the death of the surviving spouse. Very likely, this is the structure of your own trust.
But with the passage of the Tax Cuts & Jobs Act of 2017 (“TCJA”), the estate tax exemption has been increased to $11.18 million per person, at least through the year 2025. Further, the trust-split technique is no longer required to preserve the first spouse’s exemption; now, it can now be preserved for later use by the survivor merely making a timely election on a federal estate tax return. In “tax speak”, the decedent’s unused portion is now “portable” to the survivor.
This dramatic change in the exemption rules has made these older trusts quite problematic in the current tax climate. Here’s why:
Let’s say that you and your wife have an estate worth $3 million, that $2.5 million of that is your own separate property acquired prior to your current marriage, that $500K is community property. and that the value of these assets remains the same over time. Let’s further assume that your trust directs a trust split upon the first death, requiring the exemption amount to be fully funded (to the extent of the value of your estate) into an irrevocable Exemption Sub-Trust over which the survivor has only restricted access.
First Example: Let’s pretend you died back in 2001, after your trust was signed. Your estate would have been allocated as follows: $675,000 to the irrevocable Exemption Sub-Trust, and the balance of $2,325,000 to your surviving spouse. Under old law, even after fully funding the Exemption Sub-Trust, the survivor would still be left with unrestricted access to substantial assets, both of your individual exemptions would have been preserved, and the plan would have made good tax sense.
Second Example: Now let’s say you die in 2018, when the maximum exemption is now $11.18 Million per person. Your trust has not been changed and therefore still directs that the Exemption Sub-Trust be “fully funded” to the extent of your assets. The allocation would now be as follows: $2.5 Million + $250,000 = $2,750,000 into the irrevocable Exemption Sub-Trust with its provisions for restricted access, and only $250,000 into the Survivor’s Sub-Trust. Big difference.
Note: Even if your estate is comprised entirely of community property, the difference under the tax law then, and now, is still significant. If you and your spouse wish to leave the survivor with unrestricted access to your entire estate after the first death, you should have your trust reviewed and updated to meet current tax law. Very likely, your attorney may advise dispensing with the “trust-split” requirement entirely.