Irrevocable Trusts: Terminate, Decant Or Modify For Basis Step-Up?

Originally posted to Forbes.com

Many taxpayers created irrevocable trusts and transferred significant assets to them to hopefully save estate tax. Others were named as beneficiaries of trusts that others may have created. Following recent tax law changes does the existing trust plan really work? Assets in most irrevocable trusts won’t receive a basis step up on your death, leaving the specter of substantial capital gains costs. “Basis step-up” is when on death the tax basis, which is used to calculate gain or loss on sale in each asset, is marked to market. So that, for example, if you purchased a stock for $10 and on your death it’s worth $1,000, the tax basis (what you paid for the assets subject to various post-purchase adjustments) is increased to $1,000 and there will be no gain to your heirs if they sell the asset following death.

The new $15 million inflation-adjusted permanent exemption eliminates estate tax worries for most taxpayers (perhaps under 1,500 decedents a year!). That means that your irrevocable trusts may provide no estate tax savings, but they may prevent valuable income tax basis step up. That’s not the tax deal you (or whoever created the irrevocable trust) bargained for. Irrevocable trusts are very common. There are approximately 2.7 million irrevocable trusts in existence. Many of these, including any irrevocable trusts you have, should be evaluated to determine whether and how they might be changed or even terminated to get assets back in your estate for basis step-up purposes. If the trust can be terminated and distribute assets to a beneficiary, those assets may be included in that beneficiary’s estate and qualify for a basis step up.

But not so fast Quick Draw McGraw. There are lots of considerations before you pull the trust termination trigger (and you may decide not to once you’ve really evaluated the situation).

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