Does Your Existing Trust Split into Two Trusts at the First Death?

With thousands of clients, it’s not really possible for us to review a client’s documents and call or write to them individually about suggested changes. Not only is the time commitment impossible, but, quite frankly, most people wouldn’t pay much attention to it anyway.

Fortunately, most of our clients come in every so often, at which time, we have the opportunity to review the documents and make sure everything is up to date, reflects the client’s current wishes, and that the trust and other documents are set up in a way that will most efficiently provide for administration and distribution of an estate.

Twenty years ago, the estate tax exemption was less than $1 million for each person. For a married couple, this would normally mean that the couple’s estate plan would be set up to preserve the estate tax exemption of $1 million for both spouses so that they could leave a full $2 million free of estate tax.

In order to accomplish this additional tax saving, it was necessary to provide that on the death of the first spouse to die, the trust estate would be divided into two separate trusts, which required certain additional administrative actions to fully utilize the $2 million exemption when the second spouse would die.

Without these administrative provisions, the $1 million exemption of the first spouse to die would be forever lost and at the death of the second spouse, only $1 million would be exempt from estate taxes.

In 2013, the estate tax exemption was increased to approximately $11 million per person.

Since most estates are less than this amount, it became unnecessary to preserve the deceased spouse’s exemption because the surviving spouse would be able to leave $11 million without incurring any estate tax, so the doubling of this to $22 million with the split of the trust into two trusts upon the first death became unnecessary for most.

In addition, even for those with estates in excess of $11 million, where it is important to preserve the deceased spouse’s $11 million exemption, the preservation of the deceased spouse’s exemption of $11 million no longer requires the division of the trust into two trust upon the first death as long as an estate tax return is filed within nine months of the death of the first one to die.

As we meet with old and new clients, we find that many of the trusts out there continue to require this split at the first death into two trusts.

With the new law, not only is the split unnecessary, but it also complicates administration of an estate. The simple solution is to amend the trust so that upon the death of the first spouse to die, the trust continues intact, without division, for the sole benefit of the surviving spouse.

There is another benefit of not splitting the estate at death.

Under the estate and capital gain tax rules, when a person dies, the assets in their estate get a “step-up” in basis, which means the persons who inherit from the deceased person get a tax basis equal to the fair market value of the property inherited as such fair market value is determined at death.

So if you bought a share of Apple stock at $100, and then it is worth $2,000 a share when you die, you would normally expect a capital gain on sale of the stock of $1,900 per share because it appreciated in value by that much from the time of purchase.

However, where you transfer the stock as part of your estate at death, your heirs will have a tax basis in the stock equal to the fair market value of the stock on your date of death.

So in the example, the heirs would have a tax basis equal to $2,000 per share on your death, so the gain of $1,900 is exempt from taxation.

This is important because if your trust agreement requires that the surviving spouse divide the estate into two trusts at the first death, as described above, the trust holding the deceased spouse’s share of the estate will not get this stepped-up basis on the death of the second spouse to die, which may result in additional capital gain taxes to your heirs.

If you are concerned about this result, feel free to call us or send us a copy of your trust and we can quickly determine if this fix is necessary.