For many client situations, I continue to be a big proponent of using the Clayton election for flexibility in this age of estate tax uncertainty. The Clayton election continues to be the smart way, for many families, to avoid the “AB Trap” of capital gains tax and minimize estate tax as well as income tax. But what happens to a plan with Clayton election if the estate tax is completely repealed (which we can assume would eliminate provisions for QTIP election to obtain marital deduction)? Well in that event, such a plan would probably operate as a simple “AB” trust design with a bypass trust locked in (instead of the flexibility of choosing bypass, QTIP, or both).
In other words, you would likely end up with very good asset protection and bloodline protection, but you would not get a second step-up in basis at the survivor’s death and therefore the plan would fail to avoid the “AB Trap” (income tax on capital gains).
Thankfully there are several additional alternatives which may be used along with Clayton election planning to avoid capital gains tax by getting bypass trust assets included in the survivor’s estate:
- Distributing highly-appreciated assets to survivor while survivor is alive;
- Court action to modify or terminate bypass trust;
- Decanting to an estate-defective trust (since CA has no decanting statute, this is best accomplished by first using trust protector provisions to change situs of administration to a decanting state);
- Including trust protector powers to amend and grant narrowly-tailored powers of appointment in order to achieve estate inclusion, either in the surviving spouse or in beneficiaries down the line;
- Triggering the so-called “Delaware Tax Trap” — This sounds awful, but it’s a great tool potentially for those of us in states (like CA) which still have the Rule Against Perpetuities on the books. It is possible for a surviving spouse with a limited testamentary power of appointment to achieve estate inclusion if the spouse grants (to a child, for example) a presently-exerciseable general power of appointment (PEG power) which has the effect of restarting the Rule Against Perpetuities period. See IRC 1014(b)(9) and 2041(a)(3)(B).
Some of these alternatives are obviously better than others, and some conflict with common estate planning goals. Of course, good planning is almost always better than good litigating. The Clayton election plans I draft typically include several of the “high-tech” options for estate inclusion, just in case the estate tax is completely repealed.
You can meet with me for two hours at no cost and I will recommend a design for your estate plan — just follow the steps at http://Protect.LIFE to book your appointment now.