It was likely one of the few times you stepped inside an attorney’s office. You were determined to be responsible and get your estate plan in place. The attorney’s fees were paid, copies of the documents were placed in locked boxes, and you breathed a sigh relief. You received the best estate planning advice, and you thought you were prepared. However, the reality is that the estate planning landscape has changed significantly in recent years. What was appropriate planning then may not be sufficient today, so our team at CCM is continuously reviewing our clients’ estate plans to ensure that they remain relevant and appropriate.
What’s changed over the years? As is the case with most financial planning, it’s about the taxes—in this case, estate taxes. There are two common issues that we find with outdated estate plans, and both relate to how the plan attempts to reduce estate taxes through the use of a trust. First, the plan may needlessly strip the surviving spouse of flexibility. One common way estate planning attorneys deal with estate taxes is to create a Credit Shelter Trust (also called a bypass trust or A/B trust). There is an unlimited estate tax deduction for property left to a surviving spouse. This eliminates any estate tax when the first spouse dies, but may not protect the property from estate tax when the surviving spouse dies. Thus, the general idea of the Credit Shelter Trust is that some or all of the deceased spouse’s assets go into trust instead of passing directly to the surviving spouse. Unfortunately, many of the trust instruments used for this purpose assume that the Credit Shelter Trust is the best and only option and don’t give the surviving the right to receive the assets without the assets going into trust. Once the assets are in trust, and the surviving spouse is the sole trustee, he or she must be restricted to using income and principal only for needs related to health, education, support, and maintenance. Depending on the surviving spouse’s financial circumstances, the financial constraints created by the estate plan may not be ideal.
The second example can be quite costly. Until 2001, the federal and state estate taxes were identical. When estate planning attorneys drafted provisions specifying how much should go into the trust at death, it was common for the attorney to only cite the federal limit. However, the federal and state estate taxes were “decoupled” in 2001, and the federal limit has grown substantially to $5.43M in 2015 relative to the Minnesota limit, which is sluggishly creeping up to a cap of $2M in 2018. That gap is significant, and the language used in the trust document is more important than ever. For example, if a trust instrument requires that the Credit Shelter Trust be funded to the federal limit ($5.43M) without exception, there will be $3M more in the estate than is protected under the current state limit ($1.4M). The $3M may be safe from federal estate taxes, but not Minnesota’s estate taxes. Minnesota’s lowest estate tax rate is 10%, so that stroke of the attorney’s pen may cost $300,000 in unintended estate taxes.
Laws and tax codes change often, and CCM clients should know that our team, including CPAs and attorneys on staff, is constantly reviewing our clients’ estate plans to ensure that they meet the stated objectives and will avoid unintended consequences.