The essentials of an estate plan include documents which are used during your life and those used after your death.

The typical lifetime documents are a Durable Power of Attorney, Health Care Proxy and HIPAA Authorization. These documents appoint an agent to handle financial affairs (Durable Power of Attorney), make health care decisions (Health Care Proxy) and manage medical records (HIPAA Authorization) in the event that one becomes incapacitated.  These documents are critical to put in place and maintain because if one does not have these documents and the need arises for an agent, a costly, time consuming and intrusive Court process would be required to appoint a Guardian and/or Conservator.

The more commonly known documents that come into play upon one’s death are a Will and perhaps a Revocable Trust.   A Will appoints the Personal Representative who will manage the estate if there are any probate assets (assets owned individually with no beneficiary designation).  The Will provides instruction on who gets what assets, provides for appointment of guardians of minor children, if any, and provides for payment of final expenses.  If one is utilizing a Will and Revocable Trust, the Will “pours over” any probate assets to, in this scenario, a Revocable Trust so that all assets are collected in the Revocable Trust and distributed according to its terms.

We recommend retitling assets during lifetime into the name of the Revocable Trust, and thus the Trust operates during one’s lifetime as well.  One has full control of one’s Revocable Trust during one’s lifetime to modify or revoke the Trust.  From an income tax perspective, funding a Revocable Trust during one’s lifetime does not create any additional complexity for tax reporting/filing.  The Revocable Trust uses one’s social security numbers so no separate tax filing is necessary. A Trustee is named (often times oneself, then an alternate) who is responsible for managing the Revocable Trust assets and distributing income and principal and following all other instructions in the Revocable Trust.

By titling assets into a Revocable Trust during lifetime, one can avoid probate later.  Assets which name a beneficiary, such as IRA accounts and life insurance policies, also avoid probate.  We are available to assist with the retitling process after a plan is executed to make sure that one takes full advantage of the benefits of Revocable Trust planning.

In addition to avoiding probate, a Revocable Trust has built-in contingency planning.  If a Revocable Trust beneficiary has creditor problems, becomes disabled or predeceases, the Revocable Trust has alternative provisions to preserve and redirect assets.

A potential additional benefit of a Revocable Trust with estate tax provisions is the opportunity to minimize Federal and Massachusetts estate taxes.  The Federal estate tax is imposed on estates greater than $11.2 million, or nearly $22 million for a married couple.  Over time, one may accumulate more wealth, spend down, or experience fluctuations in investments and may end up with a Federally taxable estate, or not.  This large exemption amount sunsets in 8 years and reverts to the 2017 level of $5.49 million per individual.  It is entirely possible that the exemption amount could be further reduced in the future.  We recommend planning on the assumption that one will have a taxable estate so that one is prepared in any event.  The Massachusetts estate tax is imposed on estates valued at $1 million or more.  All assets owned in one’s name individually, jointly or in trust are included in the gross taxable estate.

Tax planning provisions in a tax driven Revocable Trust allows the estate of the first spouse to die to shelter amounts equal to the Federal exemption ($11.2 million) and the Massachusetts exemption ($1 million).  If one takes advantage of these provisions at the death of the first spouse, these amounts, plus appreciation, will not be taxable at the second spouse’s death.  The surviving spouse may use the sheltered amounts for health, maintenance and support.  Typically, upon the death of the survivor, the Trustee will distribute specific gifts to designated individuals, if any, or to charity or some combination, and then distribute outright or hold the remaining net balance (after taxes and expenses) in separate trust accounts for the benefit of one’s children, if any or more distant heirs.  If one has children who predecease, then one can have all of the assets for the predeceased child’s share go to his or her children; if none, then to named individuals or charities. If no one is named, the default is “heirs at law” as defined by our intestacy statute, which looks to your children, parents, siblings, aunts, uncles, cousins, etc.

Provisions can be added to accommodate large gifts for significant life events (e.g., weddings, buying a house, starting a business) to insure that such distributions are deducted from the ultimate division of assets into equal shares.  A Trust is flexible and can reflect endless specific desires.

To illustrate the estate tax planning using Revocable Trusts, if a married couple’s total estate was valued at $5 million and the assets were equally split between two Revocable Trusts ($2.5 million each), at the first death a subtrust would be established to shelter $1 million from Massachusetts estate tax at the second death. No taxes would be owed at the first death because there is an unlimited marital deduction which allows deferral of the tax as long as the spouse receives the property, including in Trust. At the second death, no federal estate tax would be due but a Massachusetts estate tax on $3 million ($3M = $5M – $1M in Trust – $1M exempted on the death of the second spouse) would be due in the amount of approximately $182,000.  By sheltering the $1M in Trust there is a tax savings of approximately $98,000. The estate tax only applies to the amount owned at death; usually the surviving spouse has spent down the funds, gifted assets or adjusted their estate plan to minimize such estate taxes.

Our plans allow the Personal Representative/Trustee to elect whether to fund the tax saving trusts at the first death.  One reason not to fund the credit shelter trusts is to direct all assets to the surviving spouse for a full step-up in basis at the second death. This would minimize capital gains taxes, which may be higher than estate taxes. Because the PR has discretion to make the election, the Personal Representative can do whatever makes sense at the time.

There are additional techniques to minimize estate taxes, including, but not limited, to the following:

• Irrevocable Life Insurance Trust (“ILIT”): If one transfers one’s current life insurance policies to an ILIT and observes the rules governing ILITs, the proceeds of the policy are not includible in one’s gross taxable estate.
  • Depending on whether one is still paying premiums on your policies, one may wish to consider whether one still wants to keep the policy or “self-insure.”
  • Depending on the type of policies and options offered by the insurance company, one may be able to convert some of this term insurance into whole life insurance or a hybrid product which provides long-term care insurance and life insurance at the same time (long-term care benefits paid out draw down from the death benefit), if interested.
• Qualified Personal Residence Trust (“QPRT”): If one transfers one’s residence to a QPRT, one retains ownership for a period of years based on one’s life expectancy; at the end of that period, ownership reverts to the beneficiary of the QPRT, but one can enter into a lease agreement to continue living there.  The tax benefit is that the QPRT freezes the value of the home at the time of transfer.  For example, if one transfers a house worth $1.2M, and by the end of the trust term, the house is worth $1.8M, one has transferred $1.8M out of one’s gross taxable estate for the “cost” of $1.2M (the appreciation). The initial transfer is a gift and is reported on a gift tax return.  The downside is that one loses the step-up in cost basis to the date-of-death (“DOD”) value.

• Annual gifting: One may wish to consider annual gifting up to $15,000 per year per donee, without using one’s lifetime gift tax exemption of $11.2M and without having to file a gift tax return.  It’s an easy way to transfer assets without any tax consequence.  If married, couples each give $15,000 in a year, they would have to file a gift tax return because of the “gift splitting” (when a married couple each give the same person a gift).

• Charitable giving: Bequests to charities are fully deductible for estate tax purposes.  To the extent one decides to include distributions to charities in one’s estate plan, this will decrease the Federal and Massachusetts estate tax liability.

• Disclaimers: Disclaimers are a form of post-mortem planning.  After the death of the first spouse, the surviving spouse can disclaim, or say “no thank you” to any of the assets that would otherwise flow to him or her.  The disclaimant is treated as having “predeceased” the decedent, and the asset flows to the next person in line, typically the next generation.  This would not minimize estate taxes as the disclaimed asset would still be included in the gross taxable estate and could generate an estate tax at the first death, but it would remove the asset and future appreciation from the taxable estate of the second spouse.

Finally, it is worth mentioning politics. The 2017 “tax reform” legislation raised the estate exemption to $11.2 million (from $5.49 million).  Even though the Federal estate tax affects very few Americans, fewer than 20% of 1%, it gets a lot of play for its relative irrelevance.  Depending on who controls Congress, there is a chance the exemption amount could be lowered or allowed to sunset back to the $5.49 million level.

In addition, there is another tax reform policy proposal which does not get as much attention but which does affect many more Americans – repeal of the step-up in basis to date-of-death values.  This is an important estate planning benefit which allows appreciated assets to escape capital gains tax on the appreciation which accumulated during lifetime up to date-of-death.

In our view, it is entirely appropriate to plan as if the current estate tax and step-up rules will be in effect, until we know otherwise. The plans we propose have built-in flexibility.  It allows the PR/Trustee to make an election to create a credit shelter trust if that produces the best outcome.  Even if there is no Federal estate tax at that time, there will likely still be a Massachusetts estate tax which could make a Credit Shelter Trust advisable.  Remember the Massachusetts exemption is $1 million, an amount easily achieved sometimes merely thanks to the real estate values.  If the step-up in basis is eliminated, the PR/Trustee has flexibility to make the best choices possible.

Real Estate Nominee Trust

Often used in conjunction with a Will and Revocable Trust, a realty trust typically holds one or more parcels of real estate for the benefit of beneficiaries who are named on a private document and not recorded at the Registry of Deeds.  This eliminates the need for probate for real estate while preserving privacy.  A realty or nominee trust also allows one to easily and privately shift the beneficial interest later.  It is one way to balance assets between spouses.