For years, estate planners have done what is considered traditional estate planning. They drafted plans primarily concerned with minimizing future estate tax liability and gave minimal attention to income tax consequences.
This was perfectly fine years ago when the estate tax was much more severe than the potential for income tax. This was attributable to relatively high estate tax rates, low estate tax exemption that was not indexed for inflation, and comparatively low capital gains rates.
Recently, however, Congress has tinkered with the tax system in a huge way. Accordingly, the income tax impact of estate planning is taking on greater significance.
More attention is directed towards the importance of income tax basis considerations in estate planning due to the narrowing between the estate tax rates and the income tax rates. In fact, in most estates worth less than $10.5 million, estate taxes are no longer an issue. Now, income taxes loom large, primarily because of the lack of attention on the income tax basis (i.e. cost or adjusted basis) of capital assets.
The bad news for most middle-class taxpayers is that for years they’ve been fed a steady diet of estate tax minimizing wills and trusts. Worse yet, they hang onto these outdated documents for many years, thinking they are done with their estate planning and not wanting to be bothered. Sadly, these old documents will no longer serve their intended purpose: estate tax minimization. While there will be no estate tax savings with these documents, because very few middle-class taxpayers will ever pay estate tax, the documents will unnecessarily increase income taxes for their heirs upon the liquidation of any assets.
Bottom line: the game starts anew. Let’s focus on income tax minimization for most taxpayers and forget about estate tax minimization. Unless your estate is worth $10.5 million or more as a couple (or $5.34 million as a single person), your biggest risk is overpaying income taxes due to inattention to income tax basis planning in your wills and trusts. Don’t make that mistake. Review your documents today.
You know the kinds of wills I’m talking about. The husband leaves everything to the wife, the wife leaves everything to the husband, and after they both die, everything goes to the children. This works well for situations in which the spouses are healthy one day and deceased the next.
However, as most of us know, life doesn’t usually happen that way anymore. Some research indicates that 69% of individuals over 65 will require some kind of long-term care in their lifetimes.
Thus, many spouses worry that if they predecease a disabled spouse who is currently in a nursing home or will require long-term care at some point in the near future, there will be insufficient funds available to provide for the institutionalized spouses’ needs. This is an especially relevant concern for expenses that are not covered under Medicaid, like a care manager, private nurse, single room, and certain therapies or drugs.
Another concern is that the availability of funds from “I love you” wills and trusts will disqualify the surviving ill spouse from eligibility for Medicaid benefits. As you know from prior articles, Medicaid is the only long-term-care governmental program in the United States. Medicare does not cover long-term custodial care.
To solve this problem many of our clients rely on a “testamentary trust:” a trust built into the will of each spouse. For many estate planners, this is counterintuitive because much estate planning occurs within the context of a revocable living trust. In order to preserve access to Medicaid eligibility without requiring that the surviving spouse spend down the assets and lose the chance to maintain a “rainy day fund,” creating a testamentary trust in the will of the pre-deceasing spouse is essential.
What this means is that around age 55, you have to completely revise your wills and trusts to accommodate a different paradigm of thought. The thinking process is no longer what happens if I die? Rather, the question is what happens if I don’t die and live a long time with expensive long-term care.
The new paradigm requires a new estate plan. If you consider yourself middle-class (meaning that your net worth will be significantly impacted by the cost of long-term care for you and/or your spouse) and are over age 55, I suggest that you revise your estate plan to reflect this newer paradigm as soon as possible.