Authored by Mark Lobb
Charles Darwin has many great quotes, but one of my favorites is as follows:
“It is not the strongest of the species that survive, not the most intelligent, but the one most responsive to change.”
You may have put a great planning structure together at one point which was considered “strong” and “intelligent,” but is it still relevant. As time passes, your life dynamic and desires change, your asset mix changes, and laws change. The form of entity, trust structure, and tax planning put in place yesterday may no longer yield your desired outcome for a variety of reasons. The following bullet point issues are examples of items which you should consider:
- Are your estate planning bequests the same today as when your trust was put in place?
- Has the value of your estate been updated in order to determine estate tax liability?
- Are your assets in a structure which provides asset protection, estate tax efficiency and fulfills your estate planning desires?
- Is your estate plan pliable to meet the needs of future generations?
- If you are a California resident, have you considered the effect of reassessment (Proposition 19) on your real property if it is transferred into an estate plan or when you die? Are there ways around reassessment?
- Have you acquired assets but not incorporated them into your estate plan structure?
- Have you drafted a letter to your trust’s trustee to provide guidance on the handling of trust assets once you pass?
- Do you have a desire today to donate funds to a charity which desire did not exist when you did your initial planning?
- Have the estate and trust laws changed in your jurisdiction since your estate plan was put in place causing certain provisions to be invalid?
- Should you take advantage of the laws of another jurisdiction to maximize tax optimization, asset protection and estate planning by moving trusts and entities to the more favorable jurisdiction?
- How can you maximize the reduction in estate tax through the use of your annual and lifetime exemptions from estate tax with your current asset mix.
- If you have already used some of your lifetime exemption, how can you continue to use up the annual increased amount of exemption through the end of 2025 when the exemption is set to be lowered?
- Tax laws are constantly changing. What laws will be changing in 2024 which will negatively affect your tax planning and how can you take advantage of the more favorable tax laws in 2023?
- Is your old succession plan still relevant and does it still provide the contemplated tax efficiencies when originally put in place?
- When is the last time you analyzed your insurance policies in the context of your estate tax planning, estate needs, efficiency of the specific policies held and the ability and desirability of converting term to whole life? Do the drivers behind your original desire to buy life insurance still exist?
The list could go on, but the point is that if you are not periodically checking in on your estate, asset protection and tax plans to make sure they are current, you may be creating a mess. Below are two items of specific consideration:
California Proposition 19 Reassessment Issues
In February 2021, the rules regarding the transfer of property from parent to child or children changed as it concerns reassessment. You may have your estate plan set up in a way which will unnecessarily trigger a reassessment of not only your home, but other real property. Furthermore, moving forward, all California real property should always be purchased in an LLC.
In 1978, California voters passed Proposition 13 (Prop 13), which stipulates that California properties be taxed on their assessed value, rather than their fair market value. The assessed value is typically the purchase price and any costs of improvements. Prop 13 allows for an increase of no more than two percent annually. If the property changes ownership a reassessment is triggered. Transfers of property between spouses are not considered a change of ownership and are exempt from property tax reassessment.
In 1986, Proposition 58 (Prop 58) became law. Prop 58 excludes from reassessment a transfer from parents to their children when the primary residence of any value is transferred or $1 million of the assessed value of other real property. Prop 58 is commonly known as the parent-child exclusion.
Prop 19 replaces Prop 58 by limiting the ability of parents to pass property on to their children without reassessment, leading to children potentially paying exorbitant amounts in property taxes. If a primary residence is to be passed to a child or the children, at least one of the children will need to make the home their primary residence. If your kids do not desire to live in your home after you pass, you should take this into consideration because the home will be reassessed once both parents pass.
As to real property other than the primary residence, we recommend you evaluate holding all real property in LLCs to take advantage of the “Change in Control Rules.” A change in control under the Change in Control Rules occurs when one party obtains more than 50% of the ownership interest of a legal entity. So long as no one party obtains more than 50% of the ownership interest in an LLC, holding real property, the real property will never be reassessed absent a change in the rules. If mom and dad own an LLC and pass leaving equal shares of ownership to their kids, as long as no one child ever holds more than 50%, there will be no reassessment. If the kids then leave minority interests to their kids, there is still no reassessment. There are many ways to run afoul of the Change in Control Rules so make sure you are well advised in how you buy and hold real property to avoid reassessment.
Californian’s Can Now Change Provisions in Irrevocable Trusts
The World of Decanting
In 2019 a new law went into effect in California allowing California trust terms to be changed through a process called “Decanting.” This process gives trustees the authority to amend or modify the terms of an irrevocable trust without obtaining court approval and in many cases, without beneficiary consent. Decanting permits a trustee with the discretion to distribute trust principal to exercise such authority and distribute trust assets to a new trust with modified provisions for the benefit of any one or more of the current beneficiaries.
A trust may be decanted to:
- modify trust terms to achieve favorable tax status, which may include reducing or eliminating rights of withdrawal or mandatory income interests to avoid estate tax inclusion.
- correct drafting errors or clarify ambiguous terms.
- update trust provisions to incorporate changes in the law, such as new trustee powers.
- convert the trust to a supplemental needs trust to ensure a beneficiary with special needs maintains eligibility for governmental benefits.
- merge multiple trusts into a single trust or divide a trust with multiple beneficiaries to maximize administrative efficiency for beneficiaries.
- add or eliminate spendthrift provisions.
- change the governing law for administrative or tax savings purposes, such as minimizing notice requirements.
- create or modify powers of appointment, which enables beneficiaries to direct trust assets to or for the benefit of a class of persons and determine how those assets are received, whether in trust or outright.
- change or update successor trustee provisions.
If you have an irrevocable trust, and you would like to make changes, you should consider the decanting process.
Miscellaneous Considerations in Updating Planning Structures
During a review of your planning structure, in order to maximize tax optimization, asset protection and estate planning, you should consider the evolving nature of your family, projected shifts in your asset mix and both outside and internal threats to your estate. Simply because you implemented a “state of the art” planning structure in years past, does not mean it is still relevant to what you want to have happened with your estate. Also, exploring the possibility of exploiting the wealth protection and preservation laws of different jurisdictions may add substantial savings and protections to your planning structure.
Being strong and intelligent is great but if you are not being responsive to change your planning structure may well not deliver to protect your estate.
