Estate planning for the other 99%

By Scott Swain, CPA, CFA, CFP, MT, Cleveland, and Nicole Rococi, CPA, MT, Youngstown, Ohio

Editor: Anthony S. Bakale, CPA

The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, made dramatic changes to the income tax regime in 2018, but it also had a significant impact on federal estate and gift taxes. Fortunately, for high-net-worth planners, the changes to the estate tax regime were simple in terms of the legislation itself. That said, the implications of the large increase in the estate and gift tax exemption are complex and affect estate planning for everyone, not just the small percentage of the population who will still file estate tax returns. This discussion focuses on how the TCJA's changes affect the 99% who will not be filing a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.

First, a review of the changes is required. The foundation of the federal estate, gift, and generation-skipping transfer (GST) tax framework was retained, under Secs. 2001, 2501, and 2601, respectively, but the lifetime estate and gift exemption amount granted under Sec. 2010(c) was increased temporarily by adding Sec. 2010(c)(3)(C). This effectively doubled the exemption from $5 million to $10 million, which is then adjusted for inflation to arrive at the revised 2018 exemption amount of $11,180,000 per individual, up from $5,490,000 in 2017. (The Internal Revenue Code uses the term "applicable exclusion amount," but this item uses the more common term "exemption.") For 2019 the exemption increased to $11,400,000.

As noted above, this increase is not permanent and is set to sunset at the end of 2025 like the majority of the personal income tax provisions in the TCJA. When the current legislation sunsets, the exemption amount will go back to roughly $6 million after inflation adjustments. Also note that the lifetime GST exemption increased to $11,180,000 along with the estate and gift tax exemption, as the GST exemption is defined under Sec. 2631 by to the exclusion amount under Sec. 2010(c). The gift tax annual exclusion increased to $15,000 for 2018 ($30,000 for a married couple), although this was a normal inflation adjustment.

Everything else essentially stayed the same, including the tax bracket structure and maximum estate tax rate of 40%. The concept of the deceased spousal unused exclusion (DSUE) as defined under Secs. 2010(c), more commonly known as "portability," was also unchanged. Under these provisions, a married individual who does not use his or her entire estate tax exemption can carry over the balance for his or her spouse to use. The important reminder here is that a portability election must be made on Form 706 for the surviving spouse to later apply the decedent's DSUE amount to his or her own transfers. Under Sec. 2010(c)(5)(A), the election is effective only if made by the due date of the estate tax return (including extensions) for the deceased spouse. There is some relief under Rev. Proc. 2017-34 if the Form 706 due date has passed. Also note that portability does not apply to the GST exemption. This is an important planning point for those with large taxable estates in order to avoid wasting GST exemption at the first death.

That completes a summary of the current state of the estate and gift tax law. The rest of this item focuses on providing estate planning assistance for the average person.

Recall how different the landscape was 20 years ago when the estate tax exemption was $650,000 with a top tax rate of 55%. Not only that, but every state levied an estate or inheritance tax at that time. Many states had authored simple statutes that levied an estate tax equal to the amount a taxpayer could claim as a state tax credit on the Form 706. The state tax credit was phased out over time and converted to a deduction under the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, which effectively eliminated the estate tax for many states and led others to repeal their estate tax. As of 2018, only 17 states and Washington, D.C., maintain either an estate tax or inheritance tax (Maryland is the only state with both), and the state exemption amounts have increased dramatically for a number of those states.

Because the exemption has increased so dramatically, the number of taxable estates has gone from small to minuscule. The most recent statistics from the Tax Policy Center, which are from 2013, indicate that only 0.18% of adult deaths resulted in a taxable estate tax filing when the federal exemption was $5,250,000. While the National Institutes of Health report 2.6 million Americans died in 2013, only 10,568 estate tax returns were filed that year, with less than half of those reporting a taxable estate, according to the Tax Policy Center. Based on these data and considering the exemption has more than doubled since 2013, it seems safe to assume that the number of taxable Form 706 filings will go down to less than 0.1% of the adult deaths for 2018 and future years.

Between the increase in the exemption at the federal level and the fact that many states eliminated their estate taxes, the playing field for estate tax planning completely changed over 20 years. Considering how infrequently the average person updates his or her estate documents — conventional wisdom is about every 20 years — one can imagine that there are a vast number of drastically outdated documents tucked away in clients' file drawers.

Estate planning has always included much more than simply strategizing about how to minimize estate taxes. Estate planning is needed to address a multitude of other nontax matters,including:

  • Custody of minor children upon the death of their parents, as well as custody of their assets;
  • Charitable goals and objectives;
  • How assets will be administered for the benefit of a surviving spouse;
  • Determination of which heirs will receive estate assets after the second death;
  • Structuring of asset distributions to these heirs, whether outright or in trust;
  • Structuring asset ownership to avoid probate;
  • Addressing complex family structures, including second marriages, stepchildren, etc.;
  • Addressing special needs or financially irresponsible family members;
  • Drafting of a durable/financial power of attorney;
  • Drafting of a health care power of attorney and living will; and
  • Review of beneficiary designations on life insurance policies and retirement accounts.

Also consider that financial institutions and medical providers are hesitant to accept power of attorney forms signed in the late 1990s. The path of least resistance is to provide copies signed in the last few years, so it is best to update these periodically.

In terms of tax planning under the new estate and gift law, the focus has shifted to income tax planning for the average person, particularly in those states that do not have an estate or inheritance tax. Sec. 1014 defines the income tax basis of property received from a decedent by bequest, devise, or inheritance as being equal to the property's fair market value on the date of the decedent's death. This is commonly referred to as a basis "step-up," and tax planning for most estates of married couples should revolve around maximizing this at the second death.

For a couple that have simple wills leaving assets outright to each other, a full step-up at the second death is easy to achieve. But when trusts are involved, it gets more complicated. The estate planning technique of creating revocable living A/B trusts has been the "go to" over the past few decades and is an excellent planning tool in the right situation. Under this trust structure, assets of the first spouse to die are divided into two trusts. The B trust, or family trust, is funded with assets that have a value equal to the remaining estate tax exemption of the deceased spouse. The A trust, or marital trust, is then funded with the remaining assets of the decedent, with those assets exempt from estate tax due to the unlimited marital deduction under Sec. 2056. What is important to remember with this trust structure is that although the assets allocated to the B trust receive a step-up in basis at death, they do not get another step-up when the second spouse passes. The assets in the marital trust, the A trust, do receive a step-up at the death of the surviving spouse since these assets are included in the spouse's taxable estate. In the authors' experience, this is not a concept that the average person recognizes or understands.

An A/B trust accomplishes the goal of reducing the estate tax to zero at the death of the first spouse and avoids estate tax on the appreciation of assets in the B trust over the surviving spouse's life. While this was excellent planning for a married couple back in 1999 when the exemption was $650,000, this is not necessarily the case in 2019 for a couple who have accumulated some appreciated financial assets.

Example: A couple's estate is valued at $4 million, with each spouse owning 50% of the assets, under a standard A/B trust. The B trust is funded with $2 million when the first spouse passes, and $0 is funded to the A trust. The B trust grows in value to $2,500,000 and has unrealized appreciation of $500,000 at the death of the surviving spouse. The appreciated assets in the B trust pass free of estate tax to the heirs at the second death, as was the goal of this trust. But the heirs receive no basis step-up, resulting in federal capital gains taxes of up to $119,000 ($500,000 × 23.8%), depending on the heirs' income tax brackets. A more appropriate set of documents could easily avoid the tax in this scenario.

While this is a significant tax issue, this trust structure can cause other potential nontax issues. Depending on the distribution provisions of the B trust, the surviving spouse could be effectively disinherited. Assume the same facts as above and that it is a second marriage situation. Also assume that the A/B trust drafting calls for the B trust to be paid at death outright to the children from the first marriage, with the A trust available for the surviving spouse to access. In this example, $0 goes to the A trust and $2 million goes outright to the children, which likely was not the intention of the spouses when the documents were drafted.

These examples illustrate a situation where total asset value is far below the current federal exemption amount, which is the case for most taxpayers today. They also present the kinds of unintended results that are written into old A/B trust agreements, given how the estate tax exemption has risen. Assisting clients with updating their estate planning documents could alleviate the two biggest issues with A/B trusts: (1) that there is no step-up on the assets in the B trust when the second spouse dies; and (2) the lack of access the surviving spouse may have to the assets in the B trust.

These trust arrangements are normally fully revocable and can be amended at any time. To avoid the problems described above, two approaches to reworking the estate documents might make sense.

First, circumstances may be such that a married couple can simply revoke the trust documents and use their wills to leave their assets to each other outright or through joint ownership. Some individuals may have only needed the trust to minimize their estate taxes. However, trusts are an excellent way to avoid probate, or there may be state estate taxes or other nontax reasons to keep them around.

Second, the trusts could be amended to build in flexibility for the trustees to allocate assets between the A and B trusts as they see fit, considering the income and estate tax situation at the time of the first death. This can work well if the trustee is the spouse or can be fully relied upon to do what is in the best interest of all beneficiaries. It gets trickier with second marriage situations, in particular.

And lastly, the use of a "joint trust" may be a much better option than an A/B trust in many cases. Joint trusts are also revocable living trusts, set up to hold all of the assets of a married couple and to provide access to the trust assets for both. Typically, at the first death, half of the assets receive a step-up in basis, but all of the assets stay in the trust. (Note that it is advisable to set up a second brokerage account to hold the investment assets receiving a step-up, simply for tracking purposes.) If the trust is structured properly, the assets of the joint trust are all included in the surviving spouse's taxable estate and, as such, receive a full step-up at the second death. The trusts will normally build in disclaimer provisions that allow the surviving spouse to shift assets into a credit shelter trust at the first death if estate tax becomes an issue down the line. This could come into play when the current estate exemption sunsets in 2026, for example.

A joint living trust has the following advantages:

  • Simplicity of one document;
  • Keeps assets out of probate;
  • Easier asset management/smaller number of financial accounts;
  • Simplifies the process of estate administration;
  • Taxed as a grantor trust for income tax purposes, so there are no extra tax returns to file; and
  • Provides control of assets to both spouses.

The final advantage in this list (provides control of assets to both spouses) could also be construed as a disadvantage where family dynamics are more complex, such as with second marriages. Another disadvantage of joint trusts is that they offer less flexibility to the surviving spouse to change trust terms after the first death in response to the surviving spouse's circumstances.

All of this is not to say that there is no relief for individuals who die with outdated trust documents. It is possible that provisions are built into the trust document that provide the trustee flexibility to allocate assets between the A and B trusts. And there is always the possibility of beneficiaries' disclaiming assets to shift assets to the A trust, but this will depend on family dynamics and the execution of the proper steps to execute the disclaimer. That said, disclaimers should be viewed as a last resort, unless they are specifically structured in the documents to provide for this A/B allocation.

One other tax factor to consider in working with clients is the estate tax regime for their resident states. In states that still have an estate tax, that tax may come into play at a much lower asset base compared with the federal exemption. A state may have an inheritance tax that applies only to certain beneficiaries. A CPA may also want to consider counseling a client to move from an estate tax state to a neighboring state that does not have an estate tax. An example would be moving from Pennsylvania to Ohio. Pennsylvania has an inheritance tax that kicks in at a fairly low level, while Ohio has no estate or inheritance tax.

More than an estate tax issue

Many people seem to think that estate planning does not apply to them since the federal tax exemptions are so high today, but the nontax factors alone certainly warrant more attention than the average person tends to give them. Couple that with the tax implications mentioned above, and one can see that there is a real need for the professional community to engage with clients to make them aware of these issues and assist in resolving them.

What approach should advisers take in helping clients plan for their estates? The first step is to engage them, especially older clients who are more likely to have old A/B trusts as part of their estate plan. CPAs who do not know should find out what kinds of documents their clients have in place and when they were drafted. Explain to them the potential landmines that could have been drafted into the documents, given how much has changed in the last 20 years. Encourage them to dust off the document package and review it with them, or direct them to review it with their attorney if you aren't as comfortable in these matters. Educate yourself on the mechanics of joint trusts, as these will likely become much more common going forward. Repeat the process every few years as estate tax legislation continues to evolve. CPAs can add real value for clients by raising these issues, and they are uniquely positioned to do it, given their role as clients' most trusted adviser and their annual touchpoint.


Anthony Bakale, CPA, is with Cohen & Company Ltd. in Cleveland.

For additional information about these items, contact Mr. Bakale at

Unless otherwise noted, contributors are members of or associated with Cohen & Company Ltd.

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