Dear Mr. Miller:
I’ve read some of your articles on fixing A-B Trusts to avoid the capital gain tax on the B Trust assets. Problem is that both of my parents are gone now and an attorney told me that the B Trust didn’t have the right provisions in it to allow what you’ve called the QTip election. Is there anything I can do now? The B trust has $250,000 of capital gain built up!
Tax Avoidance Son
Dear Tax Avoidance Son:
B Trusts and Capital Gain: B Trusts can be quite the problem now that we have an $11.4 million death tax exemption (and that can be doubled between husbands and wives quite easily). The problem, as you have pointed out, is that assets on the B Trust side typically do not obtain a step up in basis when the second spouse dies. That can leave a huge tax bill for the adult children. In your case, with a $250,000 capital gain, I would estimate a combined federal and state tax of over $60,000.
Requirements for B Trusts & QTip Election: B Trusts, to be B Trusts, must meet certain tax requirements by having certain language in the document. I have seen a number of A-B Trusts that were just plainly written incorrectly. At times, that has been advantageous as the purported B Trust wasn’t really and, therefore, once the error was identified, didn’t run into the capital gain problem in the first place. I am going to assume that you are not so lucky. Other times, the B Trust met all of the requirements to be a B Trust but did not meet the requirements to allow for a QTip election.
Court Reformation: In order to repair the B Trust so we can go the QTip route, it previously has been necessary to go to court to allow the Trust to be changed. This process was expensive and never a certain thing.
Decanting: Now, we have a new tool. It is called decanting. If you are a wine connoisseur you know that that term refers to pouring the liquid from one container into another. With trusts, it is much the same. We are pouring the assets from the original trust to a new trust with different terms. This approach is authorized by a California statute effective the beginning of 2019. Yes, there are restrictions on this approach, mainly to protect beneficiaries from being cheated out of their inheritances. But, if everyone involved is in agreement, it is tailored made for fixing A-B Trusts. And the technique is not limited to A-B Trusts. We can use it to fix/change just about any kind of trust. No court filing or hearing is typically required so it is generally less expensive than the old way. And since the court is not involved, the uncertainty of whether the judge will agree with the request is also removed.
Re-Review Necessary: Whether the problem with your parents’ trust can be fixed this way depends on the terms of the trust. One can never be certain until a complete review is made. You may wish to have your situation re-reviewed by your original attorney or by us, if you prefer.