Family Business Succession Planning May Have Income Tax Consequences
There is now increased attention to income tax issues in estate planning in lieu of death tax planning. This change is due to the increase in the estate tax exemption to $11.18 million per person under the new tax law. In addition to revocable trust planning, you should also look at existing irrevocable trusts for opportunities to improve the income tax efficiencies of such trusts.
Generally, assets you transferred to an irrevocable trust have the same income tax basis that you had prior to the transfer. You can step-up the income tax basis in these assets in a variety of ways, such as exercising a power to substitute assets back into your name before death, repurchasing assets before death from the irrevocable trust, or having an independent trustee grant you a testamentary limited power of appointment to change beneficiaries (creating estate tax inclusion).
Another powerful technique is to grant a senior family member a general power of appointment over trust assets that would cause the assets to be included in their estate for estate tax purposes, but which will not cause an actual transfer of the assets. A power that is exercisable in favor of either the family member, her estate, her creditors, or the creditors of her estate is a general power of appointment. The mere possession of a general power results in the property being included in the family member’s estate, regardless of whether it is exercised. To minimize the probability of the exercise of such power, you can require that any exercise of the power of appointment be conditioned on the approval of an independent trustee.
Although an irrevocable trust cannot normally be amended there are ways under state law, or the trust document itself, to modify the trust to achieve the desired tax outcomes. If the trust cannot be amended, it may be possible to transfer the assets from the existing irrevocable trust to a new irrevocable trust with the desirable provisions without triggering any tax.
As an example, a client created an irrevocable trust in 2012 in anticipation of the estate tax exemptions returning from $5.0 million to $1.0 million. The client originally gifted low-basis family-owned business assets to the trust, which have appreciated substantially. The trust allows an independent trustee to distribute any or all of the assets to or for the benefit of the client’s spouse and descendants. The client creates a new trust that mirrors the existing trust, except that it contains a general power of appointment to the client’s 85 year old aunt who has a modest estate. Upon aunt’s death, the assets will be included in aunt’s taxable estate and receive a step-up in income tax basis (without a physical transfer of assets). The trust now has a ‘stepped-up’ tax basis and can sell the assets, if desirable, without triggering any taxable gain.
This type of planning requires sophistication and team work with your attorneys and accountants. To see if this type of planning can benefit you, call the Estate Planning Group at Hinkle Law Firm LLC at 316.631.3131 to schedule a review with Dan Peare, Hugh Gill, or Ryan Farley.