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Reducing Income Tax Through Your Estate Plan

September 29, 2014

Due to changes in federal tax laws, now is an opportune time to review your estate plan to maximize existing estate and income tax savings opportunities.

Today’s Estate Tax Environment

The current federal estate tax exemption is $5,340,000 per person and is subject to adjustment annually for inflation. In addition, the estate tax exemption is now “portable” between spouses, meaning that any unused estate tax exemption of the first spouse to die may be later used by the surviving spouse. The possibility of this “portability election” means the combined estate tax exemption for married couples is effectively $10,680,000, an all-time high. The tax rate that applies to all transfers in excess of that figure has been reduced to 40%.

Many estate plans are drafted with a primary goal of minimizing estate taxes. One common technique is to create a “credit shelter trust” that will hold assets with a value equal to deceased spouse’s estate tax exemption. When drafted properly, the assets of a traditional credit shelter trust, in addition to the income and appreciation on those assets, will not be subject to estate tax when the surviving spouse dies. One impact of the increased estate tax exemption, however, is that fewer families need this type of tax planning.

Income Tax Opportunities

On the other hand, income tax rates have been increasing in recent years. Income in the highest tax bracket is now taxed at 39.6%, (or 43.4% if the income is subject to the 3.8% Net Investment Income Tax (“NIIT”)). Qualified dividends and long term capital gains are taxed at a 20% rate (23.8% if including the NIIT). Accordingly, families now wish to focus on reducing income taxes.

At an individual’s death, all assets subject to estate tax receive a “step-up” in income tax basis, such that the beneficiaries inherit each asset with a basis equal to its fair market value at date of death, regardless of the original cost of the asset. When the beneficiary sells that asset, the tax is based on the difference between the sale price and the new stepped-up income tax basis. Because the assets of a traditional credit shelter trust are not subject to estate tax, they will not receive this stepped-up basis at the surviving spouse’s death.

The New Credit Shelter Trust

Families are realizing that their income tax rates have increased and they are less likely to face an estate tax. Their priorities, therefore, are changing, making it important to re-examine their estate plan and its tax consequences.

One option is a new type of credit shelter trust that provides the family with flexibility to either take advantage of the high estate tax exemption or benefit from the step-up in income tax basis at the surviving spouse’s death, depending on the circumstances at that time. For more information on this new type of flexible credit shelter trust, please contact one of the Attorneys from the Trusts & Estates Practice Group.