If you and your spouse signed a living trust ten or twenty years ago, there is a good chance it will be split in two when the first of you dies. One share remains the property of the survivor. One share is locked away to save estate tax. While that design made sense when the tax limits were much lower, today it can add cost and complexity to try to prevent a tax obligation that no longer exists.
Here is what the split was built to do. Let’s take the hypothetical couple, Romeo and Juliet. They create a trust and, when the first spouse dies (let’s say Romeo), the trust holds $2 million. Under the terms of the trust, the $2 million is divided. One-half is Juliet’s to use freely. The other half, often called the family or credit shelter share, is held in a trust and controlled by an independent trustee, so if Juliet wants to use the money, she needs the trustee’s permission.
The idea behind this structure was to make sure each spouse took advantage of the Federal Estate Tax exemption. I will skip the actual mechanics, but the restricted amount in the trust is not subject to estate tax when Juliet dies. This made perfect sense when exemption limits were lower, but two changes to the law have materially changed this analysis.
First, the exemption amount has grown from $2 million twenty years ago to $15 million today. Therefore, the likelihood of owing any estate tax has been dramatically reduced.
Second, in 2011, married couples could begin combining their exemption (a concept called “portability”). Effectively, that means that Romeo and Juliet have a combined exemption of $30 million, further reducing the likelihood of owing tax. Portability also means that the restricted trust is no longer necessary for Romeo’s exemption to count. The exemption is preserved by a tax filing with the IRS after Romeo dies.
Keeping the split has real costs, both financial and emotional. The financial costs can add up. The restricted trust needs its own tax return and separate records, which have annual fees. More significantly, assets trapped in that share may not get a second step-up in basis at the survivor’s death, which can leave the children with a larger capital gains bill when they sell. For a long-held home or stock portfolio that is not “stepped-up” at the second death, the lost capital gains tax savings can dwarf any estate tax savings (which are likely zero under today’s law).
The emotional cost is also potentially significant. The survivor’s access is often limited to set standards, such as health and support, and is usually subject to an independent trustee, meaning, in our example, Juliet would have to ask a third party to use the money in the restricted trust, which can be awkward. Also, the restricted share usually becomes irrevocable when the first spouse dies, so the survivor cannot rewrite it. So, if one of Juliet’s children should not be receiving money, for instance, she would be powerless to change the terms of Romeo’s share.
There are still valid uses for this type of trust setup, but it is not something that should be automatic, as it might have been 20 years ago. It is still an effective tool for blended families, couples who want creditor protection, and second marriages, where each spouse wants to direct their own share. Also, importantly, Connecticut does not recognize portability, so the concept is still valid for tax purposes for a Connecticut estate over the single exemption amount. The point is that the split trust should be a choice, not a default.
If your trust has not been reviewed recently, it is worth reading with fresh eyes. A structure that protected your family under the old rules may be quietly costing them under the new ones.
The Bayer Bottom Line:
- An estate plan written for yesterday’s tax law deserves a fresh look.
- In the past, it was common for trusts to split a couple’s estate at the first death to shelter one share from estate tax.
- Higher exemptions and portability mean most families no longer face estate tax liability.
- The locked share brings irrevocability, extra tax filings, limited access, and a lost second step-up in basis.
- The split still fits specific circumstances such as blended families, very large estates, asset protection, and second marriages.