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3 trust changes you should tell your clients about

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A few weeks ago in this space, we discussed a couple of trusts that could basically be taken out of commission if certain tax proposals from the Obama administration come through. There are several other trusts that are affected by changes to the tax code that have already been made. These changes can be annoying in dealing with existing trusts. Yet, they also provide an opportunity for creative advisors to make fresh suggestions based on factors that might make these trusts appropriate for new types of clients — or inappropriate for clients who already have them.

The headline news is that the exemption for estate taxes has risen this year to $10.5 million for a married couple. Obviously, that won’t affect too many of your clients. According to the Tax Policy Center, only 3,800 estates will fall into the estate tax bracket in 2013 at those rates. But the tax changes outlined below have more widespread implications that could effect your current —or even prospective —customers.

Medicare taxes: A trust will owe the new 3.8 percent Medicare tax on investment income for 2013 as soon as its undistributed income reaches $11,950, which means there will be quite a few trusts subject to this. Trusts that aren’t exempt from federal taxes, such as charitable remainder trusts, aren’t subject to the Medicare surcharge either.

But it’s only undistributed income that owes the Medicare tax. If the trust disburses that income to the beneficiaries instead, the tax responsibility for the Medicare surcharge would then apply to them.

Who needs to know about this? If a client has been wavering about setting up a charitable remainder trust (or other tax-exempt trust), this might be enough to push him over the edge. Or if a client has a trust already set up but has been letting the income build up, it may be time to start disbursing those assets, especially to minors or younger adults who may be in a lower tax bracket.

AB trusts: One change to the estate tax may end up being of concern to a lot of people. The exemption for a married couple now sits at $10.5 million, and for a single person, it’s half that — $5.25 million. For a long time, there was a problem inherent in this. The second spouse to die would have inherited the first spouse’s full estate, which may have pushed him or her, as a newly single person, up toward the exemption rate.

The way around this used to be to establish an AB trust, which would keep the transferred amount out of the surviving spouse’s subsequent estate. The Tax Relief Act of 2010 made these AB trusts temporarily unnecessary, and for 2011 and 2012, the assets left by the first spouse to die would not affect the second spouse’s estate. For 2013, the portability of the estate tax exemption has been changed from temporary relief to a permanent status.

Who needs to know about this? Certainly anyone who had setup one of the old AB trusts should know that it’s probably not needed anymore. (AB trusts are still legal and could make sense for a few people, such as a wealthy unmarried couple.) But anyone bumping up against this sort of situation — where an estate would be subject to estate tax for a married couple but conceivably could reach the limit for a single person — should know about the new rules. There will be very little for the estate planner to do for those folks, but it will absolutely be a load off the clients’ mind.

Generation-skipping trusts. The portability exemption that’s now permanent for the estate tax does not apply to generation-skipping transfer taxes. So, unlike with the estate tax, the second spouse to die will not have any expansion of his or her exemption, which remains at $5.25 million.

Who needs to know about this? Anyone with a currently extant generation-skipping trust should be aware of the possibility of bumping against that limit. But this is also an opportunity for the proactive advisor to introduce the GST to any client who could even remotely benefit from one, even if it’s just to explain the new caveats.

It’s important to remember that your clients will be impressed with the breadth of your knowledge of these estate planning issues even if they themselves don’t make use of that knowledge. Even in cases where a trust doesn’t make sense for them, they will appreciate knowing someone is looking out for them.

For more on estate planning, see:

Millionaires’ biggest financial regret

529 plans: Dealing with the bad and the good

10 steps for avoiding estate planning mistakes