How Does the New Tax Act Affect My Trust?

By now, everyone has heard about the New Tax Act and how it will impact your family’s income taxes in 2018. However, the New Tax Act also made significant changes to the federal estate tax laws. Most importantly, the so-called single exclusion amount (which I usually refer to as the estate tax exemption amount) increased from $5.49 million per person in 2017 to $11.2 million per person in 2018, plus cost of living adjustments. There is a sunset clause on the single exclusion amount on December 31, 2025, which means that, on that date, the single exclusion amount will go back to the 2017 single exclusion amount of $5.49 million, plus annual cost of living increases. In general, this means that, for 2018, a single person who passes away will not have to pay any estate taxes unless his or her estate exceeds $11.2 million. In addition, for 2018, married couples do not have to pay any estate taxes on their estate when the second spouse passes away unless their estate exceeds $22.4 million. With these high estate tax exclusion amounts, estate taxes, which used to affect a large number of families in the 1990’s when the single exclusion amount was only $600,000, will hardly affect any families in the United States. Thus, if you have updated your estate plan recently, then you are probably already aware of these changes and they may have been incorporated them into your plan, but if you have not updated your trust in 15 or 20 years, then you will definitely need to go back to your estate planning attorney to have your estate plan reviewed and updated, if necessary. This blog discusses which estate plans are affected the most by the New Tax Act and gives recommendations about what kinds of changes need to be made.

“A-B” Trusts Are Unnecessary in Many Cases

Under the old estate tax laws (especially prior to 2010), many attorneys advised clients to structure their estate using “A-B” or “A-B-C” trusts to minimize or avoid estate taxes. These trusts require the division of the trust assets between two or three trusts after the death of the first spouse. It made good sense at the time (because the single exclusion amount was much smaller), but today this structure is no longer required for most clients. A-B or A-B-C trusts now produce unnecessary costs and administrative burdens, such as:

• Placing a significant administrative burden on surviving spouse. After the first spouse dies, the surviving spouse must divide the entire marital estate into two or three separate trusts. This is a time consuming and sometimes confusing process, especially while the family is going through the grieving process.
• Assets must be retitled. The surviving spouse must retitle assets in order to place them into the correct trust following the death of the first spouse.
• Higher costs. Managing multiple trusts requires the filing of additional income tax returns, which means more money spent on tax professionals and/or attorneys each year.
• The A-B trust cannot be converted to a simple trust after the death of the first spouse without court approval. It is a costly and burdensome process to convert an A-B or A-B-C trust to a simple trust after the first spouse has died. Amendment typically requires court approval and often costs thousands of dollars in legal fees.

Changing an A-B Trust to a Simple Trust

Under the New Tax Act, most families stand to reap significant benefits from amending their estate plan to a simple living trust (or in some cases a different type of trust known as a QTIP trust, which I will discuss more in a future blog), such as:

• Simplification of your estate plan. The increased estate tax exemption means that most of our clients no longer need the more complex A-B or A-B-C trust to avoid estate taxes. Quite simply, the overwhelming majority of estates will pay no estate tax.
• Give the surviving spouse more control over his/her assets. A-B trusts contain inflexible funding formulas that force substantial assets owned by the deceased spouse into the decedent’s trust to minimize taxes — a surviving spouse could feel “disinherited” and left with less control over the assets at the first spouse’s death. This can cause a real problem if the surviving spouse needs unrestricted access to the funds.
• Save on administrative expense and, in some cases, capital gain taxes. Amending your trust to a simple trust greatly streamlines the administration process, saving time, money, and, in some cases, capital gains taxes.
• Avoid costly mistakes. Many families forget to “split” the estate into the decedent’s trust and survivor’s trust upon the death of the first spouse. This leads to confusion when it comes time to administer the estate and could require the successor trustee to go to court to get approval to correct the mistake – this is a costly and time-intensive endeavor.

Our Recommendation

For some families (especially those with estates over $11.2 million), there are still some advantages to keeping the A-B or A-B-C trusts in place.  However, for most families, we recommend that they take advantage of today’s higher single exclusion amount to lower expenses and the administrative burden for your spouse and loved ones. Have your plan reviewed to see if you would benefit by switching to a simple living trust. The cost of converting to a simple living trust now would be less than the first-year cost of administering an A-B or A-B-C Trust.

Of course, beyond the need to convert to a simple living trust, it is also important to have your estate plan reviewed every few years to address other changes to your family and new legal developments that will help to improve your estate plan.

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