Estate Planning Word Circle Concept White Center

Continuing [Part 1] of my blog on this subject, like so many things in life, nothing is completely black and white and cast in stone. So while the increased lifetime exclusion amount and the introduction of the portability concept to permit the surviving spouse to utilize the unused lifetime exclusion amount of the deceased spouse appeared at first blush to likely replace the split trust concept in many situations, some commentators and practitioners are now rethinking prior positions taken.

By utilizing a trust instrument creating the split trusts (Survivor’s Trust and Decedent’s Trust) at the death of the first spouse, if the property allocated to the Decedent’s Trust increases substantially in value from the death of the first spouse to the death of the second spouse, that appreciation would not be subject to federal estate tax at the death of the surviving spouse and would not need to be dealt with for possible federal estate tax obligations until the ultimate deaths of the residual distributees after the death of the second spouse, presumably their children.

As mentioned in Part 1 of this blog, a Decedent’s Trust also affords creditor protection for the surviving spouse, which is not generally available in the single trust scenario where all assets of the couple are subject to creditors’ claims (with some exceptions). And the split trust concept may be the preferred route when the deceased spouse has children of a prior marriage that could possibly be excluded by the surviving spouse with the single trust being utilized.

There are, however, a few negative implications using the split trusts. The property allocated to the Decedent’s Trust does not receive an additional step-up in cost basis at the death of the surviving spouse. It retains the same cost basis it received as of the date of death of the deceased spouse. So if this property is sold for a gain either before or after the death of the surviving spouse and has substantially appreciated in value, there will be no additional federal estate tax (until death of the residual trust beneficiaries), but there will be federal and state income tax consequences.

On the other hand, if a single trust is utilized by the couple for their primary estate planning document and the decedent leaves his or her interest in the community estate and his or her separate property to the surviving spouse, there will be no estate tax at the decedent’s death because of the unlimited marital deduction. But all of the couple’s property will be included in the gross estate of the surviving spouse. And since the surviving spouse then owns all of the property, all of the property will receive a step-up in cost basis to fair market value at the death of the surviving spouse.

If the deceased spouse had the maximum unused applicable exclusion amount available, the surviving spouse could shield a maximum of $10,680,000 from federal estate tax (based on 2014 numbers).  And since all assets would receive a stepped-up cost basis at the surviving spouse’s death, any assets sold shortly thereafter would likely avoid any significant income tax (or at least reduce the income tax bit substantially) on subsequent sales.

(continued in Part III in a few days)


Michael W. Margrave