How many of you have a client who is the current beneficiary of their deceased spouse’s trust? Have you reviewed the terms of the trust or its current assets recently? Taking the time to do so may present an opportunity to save your client a significant amount of money. Ask yourself, “How much could be saved in income taxes and capital gains taxes by distributing income and/or assets out now or dissolving the trust now?”
In 2014, trusts will be subject to the maximum tax rates on any income over $12,150. It doesn’t take much to meet that threshold. As a result of new tax laws passed in 2013, the highest income tax rate is now 39.6 percent, the maximum tax rate for long-term capital gains and dividends is 20 percent, and a 3.8 percent “Medicare” tax is imposed on investment income (including capital gains).
Most of us have clients who established typical A-B trusts when it made perfect sense to do so. A number of those clients now face a much different set of circumstances that do not include a risk of owing federal estate taxes upon the death of the survivor. As a result, surviving spouses who are the lifetime beneficiaries of their deceased spouse’s trusts may have no reason to be; and, in fact, it may be more beneficial for them to terminate those trusts (if at all possible).
Picture this: Your dad died four years ago. In life, he established an A-B Trust naming your mom as the lifetime beneficiary. He died with approximately $500,000 in trust assets (held in a brokerage account), all of which were funded to the B Trust (Family/Bypass Trust); nothing is held in the A Trust (Marital Trust). The B Trust gives the trustee the discretion to distribute income and/or principal to mom for health, education, support and maintenance during her lifetime, and upon your mom’s death, the balance of the B Trust will be distributed out to you and your three siblings in equal shares. Currently, the brokerage account has grown in value to more than $600,000.
Hopefully the trustee is exercising its discretion to distribute the net income out to your mom each year so that the income tax owed is based on her tax bracket as opposed to the trust’s tax bracket. This alone would save thousands of dollars long-term. But another issue the trustee needs to consider is capital gains taxes. The assets in your dad’s B Trust do not gain a step up in basis on your mom’s death. When they are eventually sold, there will be capital gains taxes owed on the growth in value since his death, which amounts to more than $100,000. But what if the trust’s terms allowed the trustee to terminate the trust or distribute all principal to your mom, even to the extent of exhausting the trust? This would allow your mom to transfer the brokerage account to herself or her trust; however, to avoid capital gains, the transfer would be an in-kind distribution and not a sale. At her death, the assets would gain a step up in basis and you and your siblings would escape the capital gains tax that would’ve been paid if it had remained in your dad’s trust. This could amount to a significant savings in many circumstances.
Remember, also, that MCL 700.7416 allows the court to modify the terms of a trust to achieve the settlor’s tax objectives in a manner that is not contrary to the settlor’s probable intention. Further, MCL 700.7412 allows the court to modify the administrative terms of a trust if continuation of the trust on its existing terms would be impracticable or wasteful or impair the trust’s administration. The potential capital gains tax savings could be so great in an appropriate situation, that it may be worth petitioning the probate court to modify the terms of a trust where the terms of the trust do not allow termination or exhaustion of the trust’s principal under the current set of circumstances your client faces. It is also worth exploring whether your particular trust can be terminated under MCL 700.7414, which allows the trust to be terminated if the total value of trust property is less than $72,000 (in 2014) and the trustee concludes that the value of trust property is insufficient to justify the cost of administration.
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For more information, contact Melisa Mysliwiec at Fraser Trebilcock, 40 Pearl Street NW, Suite 910, Grand Rapids, Michigan 49503, (616) 301-0800, or e-mail her at mmysliwiec@fraserlawfirm.com. You may also reach Melisa, or any other member of Fraser Trebilcock's Trusts and Estates Department, at its Lansing office, located at 124 West Allegan Street, Suite 1000, Lansing, Michigan 48933, (517) 482-5800.
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