The Optimal Basis Increase and Income Tax Efficiency Trust: Exploiting Opportunities to Maximize Basis, Lessen Income Taxes and Improve Asset Protection for Married Couples after ATRA (Or: Why You'll Learn to Love the Delaware Tax Trap)

227 Pages Posted: 16 May 2014 Last revised: 10 Feb 2017

Edwin P. Morrow III

Key Private Bank Family Wealth Strategy Group

Date Written: January 1, 2016

Abstract

In Part I, the author describes the main income tax problems with the current design of most AB trusts in light of portability and the new tax environment – and problems with more simplified "outright" estate plans.

Part II describes potential solutions to obtaining a step up in basis at the surviving spouse's death, including the use of various marital trusts (and the key differences between them), and why these may also be inadequate.

Part III explores how general and limited powers of appointment and the Delaware Tax Trap can achieve better tax basis adjustments than either outright bequests or typical marital or bypass trust planning. The paper refers to any trust using these techniques as an Optimal Basis Increase Trust ("OBIT").

Part IV discusses how these techniques accommodate disclaimer based planning (or disclaimers from lack of planning), and how qualified disclaimers by a surviving spouse can paradoxically increase the survivor's tax basis in inherited assets at the death of the first spouse to die.

Part V discusses how married couples can achieve a "double step up at first death" without living in a community property state, comparing the various techniques. Furthermore, it explores how to benefit from leveraged "upstream" planning to achieve a basis increase on assets when an older relative dies.

Part VI discusses new asset protection opportunities opened up by the increased gift tax exclusion and the appendix includes a comparison chart outlining asset protection planning options outside of using domestic asset protection trusts.

Part VII discusses the tremendous value of applying OBIT techniques to pre-existing irrevocable trusts, and walks through the minefield of when such amendments and reformations carry a risk of adverse income, estate or GST tax results.

Lastly, Part VIII discusses various methods to ensure better ongoing income tax treatment of irrevocable trusts – not just neutralizing the negatives of trust income taxation, but exploiting loopholes and efficiencies unavailable to individuals, including how a taxpayer might get an "above the line deduction" for gifting to their children. These techniques include using trust provisions to make capital gains or other income taxable to a beneficiary with withdrawal rights under IRC 678 and exploiting regulations that permit capital gains to be taxed to a beneficiary and flexible charitable deductions available to trusts.

These techniques taken together are referred to as an Optimal Basis Increase and Income Tax Efficiency Trust. The appendix includes simple infographics and several comparison charts to illustrate these concepts. These include charts comparing various options regarding options available to preexisting irrevocable trusts, comparing various design options for married couples, and comparing various techniques to step up all of a married couple's assets at the death of the first spouse.

Keywords: income tax, basis, tax shifting, asset protection, disclaimer, irrevocable trust, Section 678(a), grantor trust, Section 642(c), Delaware tax trap

JEL Classification: K34

Suggested Citation

Morrow, Edwin P., The Optimal Basis Increase and Income Tax Efficiency Trust: Exploiting Opportunities to Maximize Basis, Lessen Income Taxes and Improve Asset Protection for Married Couples after ATRA (Or: Why You'll Learn to Love the Delaware Tax Trap) (January 1, 2016). Available at SSRN: https://ssrn.com/abstract=2436964 or http://dx.doi.org/10.2139/ssrn.2436964

Edwin P. Morrow III (Contact Author)

Key Private Bank Family Wealth Strategy Group ( email )

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