If your trust requires a division of assets into two sub-trusts on the death of the first spouse, your current trust may no longer suit your needs. (Look to see if your trust mentions a Bypass Trust, “B” Trust, Exemption Trust, Marital Trust, or Family Trust). Many couples created their trusts before 2011 when there was a dramatic change in the tax code. In addition to higher exemption amounts (the amount of money individuals can gift their children and non-spouse beneficiaries during life and at death), the manner in which couples can transfer that wealth also changed.
Prior to 2011, married couples were required to divide assets into two separate trusts when the first spouse died to preserve the amount the deceased spouse could pass to his or her children without estate taxes. The downside to dividing assets on the first death is that it requires that the surviving spouse allocate assets between the two trusts and retitle all the assets. In addition, the surviving spouse must file an annual tax return for the trust that holds the deceased spouse’s property. The assets in the deceased spouse’s trust receive a new cost basis (fair market value). However, the assets in the deceased spouse’s trust do not receive another step-up in basis when the surviving spouse dies. Only the assets in the surviving spouse’s trust receive a stepped-up basis.
Under the Tax Relief, Unemployment Reauthorization, and Job Creation Act of 2010, all of that changed. Now, the surviving spouse can elect to “port over” and add the deceased spouse’s exemption amount by timely filing an estate tax return. This allows the surviving spouse to avoid all the downsides of funding the two sub-trusts on the first death. However, if your current trust requires the division of assets into two sub-trusts, you cannot simply ignore what that document states will happen on the first death because your trust is a contract. If you fail to observe the provisions of the trust, significant tax, and legal consequences may result. Your trust needs to be amended.