Put Your Plan in Order. Part 2: Updated Planning for Clients with Married Separate Trusts

 Put Your Plan in Order. Part 2: Updated Planning for Clients with Married Separate Trusts

Sometimes I’m asked if I’m concerned that changes to federal estate tax law will result in there being less work for me to do in my practice. I reply that I’m not concerned and that the changes to the federal estate tax law just mean that I’ll be dismantling all the planning during the second half of my career that I spent the first half of my career creating for clients.

That, of course, is not a serious response, but there is an element of truth in it. Changes in federal estate tax law have resulted in a need for individuals to consider their past planning and whether changes should be made to that planning in light of visions in the new law.

Past Strategy Routinely Included Trusts for Both Spouses

In the 1990s and throughout the last 10 years, estate planning lawyers routinely drafted what we referred to as “Married Separate Trusts” consisting of “A-B trusts” or “marital-family trusts” in an effort to double any applicable individual federal estate tax credit for married couples. This strategy resulted in shielding the first spouse’s estate from estate taxes, letting the estate grow while the surviving spouse was alive and also had access to the first spouse to die’s assets for his/her benefit. At the second death, both the assets in the first spouse to die’s trust and the second spouse to die’s assets would pass to the heirs, in many cases estate tax-free.

This strategy was particularly important when individual credit levels from federal estate tax were $600,000 per person and later stepped up to credit levels of $1,000,000, 1,500,000, etc.

During the past several years, as credits levels increased to $3,500,000 then to $5,000,000 on a temporary basis, I assisted several of my clients in mending their married separate trusts to provide greater flexibility for the surviving spouse to make a decision after the first spouse to die on whether or not to continue to leave the first spouse to die’s trust in place for tax planning purposes. The amendments I drafted allowed the surviving spouse to make that decision based on the value of that particular couple’s estate and the applicable federal estate tax credit for the surviving spouse. If the credit for the surviving spouse was more than the value of the entire estate (both the assets in the first spouse to die’s trust and the assets in the surviving spouse’s trust), then it would make sense for the surviving spouse to simply terminate the first spouse to die’s trust and avoid the complications of having to move forward with administering two trusts.

New Tax Rules Make Married Separate Trusts Unnecessary

Congress, in December 2012, passed new tax laws that did two important things relating to federal estate tax. First, Congress made permanent what was temporary to the individual estate tax credits and established that credit amount at $5,000,000 to be adjusted for inflation, which has resulted in a current credit amount of $5,250,000 per person.

Second, the new laws now recognize the concept of “portability,” which basically means that a family under certain circumstances can pull forward and apply the first spouse to die’s credit at the time of the second spouse’s death without the first spouse to die needing a separate trust. The effect of these changes has now simplified estate planning for many clients. The net effect of these changes is that married couples with less than $10,000,000 in assets can pass their assets to their heirs and beneficiaries estate tax-free without complex trust planning.

The Solution for Couples with Married Separate Trusts

Trust planning is still relevant and necessary in some situations with respect to married couples’ estates worth more than $10,000,000. In addition, trust planning remains a preferred method to avoid the necessity to probate assets after both spouses die in order to transfer title from the parents to their children or other beneficiaries.

The resulting solution for married couples who now have married separate trusts is to simply restate the separate trusts into one joint trust, which is a much simpler and more straightforward trust. This is mainly designed to allow the couples to act as trustees of the trust during their lifetime, retaining their full control, and then appointing a successor trustee to manage those assets in the event they are not capable to do so, including after their death. This type of joint trust will then simplify the administration of a married couples trust, avoid probate and further avoid the necessity of having to administer two trusts under planning strategy that was aimed at solving a problem that has now been removed based on changes to federal estate tax law.

What Happens If a Couple Does Not Change Their Plan?

There is no requirement for married couples with separate trusts to do anything to update or change their plans. These trusts as drafted remain valid and will work pursuant to the trust terms. The only downside of not updating these trusts is that a surviving spouse or children as successor trustees will have some additional administrative procedures to follow, which otherwise could be avoided.

In conclusion, if you and your spouse have married separate trusts, it would be worth your while to discuss your planning with the attorney who established those trusts and determine whether your estate plan can be simplified by restating those trusts into a joint trust.

The recent developments in the change in the federal estate tax law once again confirms estate planning is “fluid” and definitely a “process” vs. an “event.”