Many of you may have had your estate plan prepared at a time when the exemptions from Federal estate tax were much lower and the ability to use a deceased spouse’s exemption was unavailable. To ensure that a married couple maximized the use of the available exemptions, your estate plan may have been structured so that upon the death of one spouse, two subtrusts were automatically created for the benefit of the surviving spouse.  

The estate tax laws have changed and exemptions from Federal estate tax were permanently set at higher levels. In addition, married couples are permitted to transfer any unused Federal estate tax exemption to a surviving spouse by way of a concept known as ‘portability.’ Thus, the need for an automatic allocation between two subtrusts upon the death of one spouse is no longer necessary in certain circumstances and may have unintended income tax consequences as follows.

As you may know, upon the death of one spouse, the tax basis in certain assets owned by that spouse is adjusted to the fair market value as of the date of death. This adjustment is often referred to as a “step-up” or “step-down” in basis. Assets funded into the subtrusts will receive a basis adjustment on the death of the first spouse. Upon the death of the surviving spouse, only assets held in one of the subtrusts (i.e., the Marital Trust) will be adjusted to the fair market value as of the date of death of the surviving spouse. The assets of the other subtrust (i.e., Credit Shelter or Bypass Trust) continue with the same tax basis that was received upon the death of the first spouse. Therefore, the beneficiaries under your estate plan after both of you are gone may pay more in capital gains tax on any assets held in the subtrusts if automatic allocation is made between the subtrusts and the assets appreciate in value after the date of death of the first spouse.

To provide maximum flexibility to the family following the death of the first spouse, you should consider amending your estate plan to remove the automatic allocation and having all the assets pass to one subtrust. The surviving spouse would then have the ability to reallocate (i.e., disclaim) a portion of the assets, if necessary, but the reallocation would be made after evaluating both the income tax and estate tax situation at that time.

Realizing this may be a lot to digest, the main point is that if you have not recently reviewed your estate plan, you should do so to see if any changes need to be made. Rest assured that any change would be implemented only after collaboration and concurrence of all of your advisors (i.e., your financial advisors, your accountant and your attorney).