When married couples establish trusts as part of an estate plan, their primary goal is often to protect access to resources and eligibility for critical benefits while simultaneously reducing the likelihood of a surviving spouse owing a significant amount in capital gains taxes after the passing of the other spouse. Both spouses may contribute to their joint trust as a means of protecting their resources, establishing support for one another and potentially preserving assets for other beneficiaries in the future.
Creating the right type of trust and engaging in appropriate valuations after the passing of either spouse can help maximize the protections extended by a step-up in basis for trust assets while minimizing the potential financial exposure of a surviving spouse.
What is a step-up in basis?
A step-up in basis is the adjustment of the fair market value of critical assets at the time of an owner’s death. In many joint trust scenarios, surviving spouses may only be eligible for a partial step-up of trust assets, resulting in substantial capital gains tax exposure.
The surviving spouse has substantial unrealized capital gains, which are essentially profits on paper for resources that may have appreciated in value, although they do not take any steps to access that value. Their liability may then pass to their beneficiaries after they die due to the increased fair market value of trust assets.
Certain types of trusts offer better protection
More thorough, advanced trust structures can help provide enhanced financial protection for surviving spouses and other joint trust beneficiaries. A Joint Exempt Step-Up Trust (JEST) offers protection for both spouses during their lives and for surviving spouses when one spouse passes.
Assets held in a JEST remain in the initial trust while both spouses are alive. Once one spouse passes, a portion of the resources transfer to a Credit Shelter Trust to maximize the exemption available to the deceased spouse, while other assets move into a Qualified Terminable Interest Property (QTIP) trust for the surviving spouse. Other options may include a Spousal Lifetime Access Trust (SLAT) or a Grantor Retained Annuity Trust (GRAT).
Creating a trust that allows for the adjustment of the fair market value of critical resources can protect surviving spouses and other beneficiaries from some substantial capital gains taxes when both of the initial trustors eventually die. Working with an estate planning firm familiar with more complex trusts can be crucial for the protection of married couples concerned about preserving their resources and limiting tax exposure.