Trust-Busting: Un-planning Your Estate (Conclusion)

If your spouse or loved one has passed away without updating his or her plan and you find yourself now the trustee or beneficiary of a trust that is not needed, there are ways that you may terminate the trust and end the costs and hassles of trust administration.

Now, not only is the exemption $5.25 million, but the exemption of the first spouse to die is portable meaning that it can be transferred to the surviving spouse and used without the need for a trust.

What if your spouse died years ago? If your own assets plus what’s in the trust are below $5.25 million, your family will probably save a lot of income tax if you can get rid of the trust. When you die the tax basis of your own assets (but not those in the trust) get “stepped up” to their date of death value. If the beneficiaries sell the assets right away, there is no capital gain or loss. Getting assets out of trust and into the surviving spouse’s hands will allow the assets to get a step up in basis on the death of the surviving spouse. Also, if income is left accumulating in the trust, it incurs income tax at a very compressed rate schedule. Undistributed trust income above $11,950 is taxed at the highest individual income tax rate, which is now 43.4% on interest and 23.8% on capital gains and dividends.

Federal taxes are important, but they aren’t the only consideration. Before you try to bust the trust, you need to evaluate whether a trust is needed to help save state inheritance taxes. Also, you need to consider the creditor’s protection it provides, as well as the control it provides over the ultimate disposition of the assets, for example, the ability to leave them to a new spouse. If the trust has tax losses, they may be lost if the trust is terminated, so keeping the trust going may be the better course.

Sometimes, the trust by its own terms can be terminated if it is too small or the costs of its administration are uneconomical. Also, many such trusts include liberal discretion for the trustee to make principal distributions to the beneficiary and this may be a way of terminating the trust.

Even though a testamentary trust is irrevocable, there are ways to terminate an irrevocable trust under Pennsylvania law since the enactment of the Uniform Trust Code if all of the beneficiaries consent. Generally, such a termination requires court approval, but if it can be shown that the continuance of the trust no longer serves the purpose for which it was intended, a non-judicial settlement agreement may suffice. For example, if a bypass trust is used to keep the trust assets from being taxed in the beneficiary’s estate and with the $5.25 million exemption, no tax would be due anyhow, the trust’s purpose is not being served.

If the opinion of legal counsel is that the trust can’t be terminated under Pennsylvania law, there is another possible solution: change the situs of the trust. Many times the trustee can do this, or the trustee and beneficiaries by consent can do this. The trust can be moved to a jurisdiction whose governing law is more liberal or better addresses the facts and circumstances of a particular trust.