Unfortunately, the future of estate tax law is presently in flux, which makes planning more difficult. Under the present law, on January 1, 2011, the estate tax exemption returns to $1,000,000. However, Congress and the President have been talking about increasing the estate tax exemption from the $1,000,000 to $3,500,000. On the other hand, in 2009 they had been talking about continuing the estate tax in 2010 and keeping the exemption at $3,500,000 and failed to do so. Therefore, we do not presently know whether the estate tax exemption will be $1,000,000, or $3,500,000 or more beginning in 2011.
To protect assets from estate tax, a typical “AB” or “ABC” Trust requires that the share of the Trust assets of the deceased spouse go into the “B” (we call it “Exemption”) Trust. If we were certain the exemption would remain at $1,000,000, we would recommend the trustee actually retitle the assets, using a new taxpayer identification number. This would keep the assets, including any accrued income and appreciation, out of the surviving spouse’s estate.
However, actually retitling assets into the name of the Exemption Trust comes at a price. Because it has its own taxpayer identification number, the Exemption Trust generally must file its own income tax return each year. If the estate tax was a certainty, the fees for such returns would pale in comparison to the estate tax that the trust beneficiaries would pay at the death of the surviving spouse (up to 55 cents of every dollar over the estate tax exemption amount). But if the exemption is changed to $3,500,000 (and the assets do not exceed such amount), there will be no estate taxes to worry about, and so funding the Exemption Trust would not justify the added expense. In addition, assets in the Exemption Trust do not get another “step-up in basis” to the fair market value upon the death of the surviving spouse. This means that if the assets appreciate between the deaths of the two spouse, the Trust will have to pay taxes on the gain when the assets are eventually sold (either after the death of the surviving spouse or later).
We will likely finesse the issue on most Trusts where the first spouse dies in 2010. We will do the allocation on paper, likely fund the home into the “A” Trust, and wait to see what happens later in the year.