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Estate Planning Essentials: May 2017
Chambliss Estate Planning Essentials brings you legal developments and other trends of vital interest in the world of estate planning. This post is brought to you by David Hunter and other members of the Estate Planning Practice Group of Chambliss Law Firm.
Keep Your Millions and Avoid Unnecessary Expense:
Benefits of a Tennessee Community Property Trust
Many of you may have an estate plan in place, but when was the last time you updated it? As we age, most of us are saving for retirement, making investments, and planning for our loved ones’ futures. Having a plan is great, but making sure it’s updated to fit your needs and lifestyle changes is just as important. One important and relatively recent planning tool now available to Tennessee couples is the Tennessee Community Property Trust, which when implemented wisely can save a surviving spouse a significant amount of capital gains tax. Consider this example:
John Smith was raised in Omaha, Nebraska. His father gave him $1,000 in 1964 to invest with fellow Omaha resident, Warren Buffett. John and his wife, Mary, moved to Tennessee in 1965 where they spent the rest of their lives together. Although John loved his Berkshire Hathaway stock and refused to sell it during his lifetime, he knew Mary would want to sell it after his death.
In 2007, John and Mary established a joint revocable trust into which John transferred his Berkshire Hathaway stock to help avoid the need to probate their estates.
In a recent visit with their estate planning attorney, the attorney suggests that Mary may be able to avoid over $1.5 million in federal income tax when she sells the Berkshire Hathaway stock after John’s death if John and Mary amend and restate their existing joint revocable trust to make it a Community Property Trust.
Please contact us if you would like to discuss whether you can benefit from a Tennessee Community Property Trust. For background and additional details regarding this trust, see below.
BACKGROUND:
Since 1948, federal tax law has provided an income tax advantage to residents of community property states (Louisiana, Texas, New Mexico, Arizona, California, Washington, Idaho, Nevada, and Wisconsin) which was unavailable to residents of common law states (such as Tennessee). Section 1014(b)(6) of the Internal Revenue Code grants a full “step up” in basis for all community property owned by a couple upon the death of the first spouse in contrast to only a one-half “step-up” in basis for property owned by a similar couple residing in a common law state. In an effort to provide a means by which married couples owning common law property may obtain the income tax basis benefits associated with community property under Code Section 1014(b)(6), the Tennessee legislature enacted the Tennessee Community Property Trust Act of 2010.
PURPOSE:
As illustrated in the above example, the Community Property Trust provides married couples with a joint, revocable trust that both avoids probate on assets held in the trust and provides a full capital gains tax basis step-up on trust assets upon the first spouse’s death.
WHO CAN USE THE TRUST:
Tennessee residents and nonresidents may use the Community Property Trust. While both spouses are living, at least one trustee must be a Tennessee resident or a bank or trust company licensed in Tennessee.
BENEFITS:
- Revocable and Amendable – The married couple establishing the trust can revoke and amend the trust agreement at any time during their marriage. If the trust is revoked, each spouse receives one-half of the trust assets.
- Income Tax Benefit – The trust can be used to achieve a full fair market value capital gains tax basis step-up for all of the assets in the trust upon the first spouse’s death. This basis step-up can result in substantial income tax savings if low basis assets must be sold to provide funds to the surviving spouse after the first spouse’s death.
- Avoid Probate – The delay, expense, and public nature of probate can be avoided when this type of trust is utilized.
- Distributions While Both Spouses are Alive – The married couple generally retains all rights to the income and principal of the trust and can withdraw funds as needed.
- Gift and Death Taxes – The trust can be structured to effectively use the estate tax exclusion amounts of both spouses.
DISADVANTAGES:
During a married couple’s lifetime, the assets in the Community Property Trust remain exposed to the claims of the couple’s joint and individual creditors. If a higher level of creditor protection is desired, a couple should consider a Tenancy by the Entirety Trust or Tennessee Investment Services Trust, which provide additional protection in exchange for a loss of the full capital gains tax basis step-up.
Example Data
Tax Consequences Under:
| Old Revocable Trust | Community Property Trust | |
|---|---|---|
| Stock Sales Price[1] | $13,000,000 | $13,000,000 |
| Less: Tax Basis | $6,500,500[2] | $13,000,000 |
| Equals: Capital Gain | $6,499,500 | $0.00 |
| Taxes Due[3] | $1,546,881 | $0.00 |
[1]An investment of $1,000 in Berkshire Hathaway in 1964 would be worth over $13 million today. (https://finance.yahoo.com/news/heres-rich-youd-had-bet-190300243.html)
[2]$6,500,000 date of death fair market value of one-half of the stock deemed to pass from John’s estate plus $500 carryover basis of one-half of the stock deemed to be held by Mary at the time of the stock sale.
[3]Capital Gain x 23.8% (20% long term capital gain tax rate plus 3.8% net investment income tax rate). Tennessee Community Property Trusts have not been “tested” by the IRS. Although Tennessee’s Act is based on a similar Alaska statute which has been in existence for more than 15 years, if the IRS were to prevail in a challenge to the effectiveness of Tennessee’s Act, the full basis step-up may not be available.
