Co-Author: Jeffrey D. Cohen, Esq., C.P.A.
Did you create an irrevocable trust years ago to reduce estate taxes? If so, recent tax changes make this a perfect time to revisit your irrevocable trust as part of your overall estate and tax planning. Many families who once focused on estate tax minimization may find that income tax planning has become the more important consideration.
Understanding the New Estate Tax Exemption
While irrevocable trusts are traditionally designed to remove assets either during life or at death from the grantor’s estate for estate tax purposes, 2026 has introduced a new tax-planning environment due to the increased estate tax exemption. Recent federal legislation has set the estate tax exemption at $15 million per individual for those who pass away in 2026 and is indexed in future years for inflation, meaning that an individual may transfer up to that amount during lifetime or at death free of federal gift or estate tax. For married couples, this exemption can effectively be doubled to $30 million with the use of portability. Barring any future legislative changes, this exemption amount is expected to remain in place going forward.
In prior years, when the estate tax exemption was significantly lower (For example – In years 2002 and 2003 the exemption was just $1 million per individual compared to $15 million today), estate planning strategies often emphasized the creation and funding of irrevocable trusts to remove appreciating assets from the grantor’s taxable estate. These strategies were highly effective in minimizing estate tax exposure.
Why Income Tax Planning is Becoming More Important
In this new high estate tax exemption environment, however, the focus of planning may shift away from estate tax planning and towards income tax planning. For many clients whose estates fall below the current exemption threshold, estate tax minimization is no longer the primary concern. Instead, income tax efficiency, particularly with respect to minimizing income tax on highly appreciated assets such as stocks, securities, and real estate, has become increasingly important. As a result, it may be more tax-efficient in certain circumstances to cause assets held in irrevocable trusts to be included in the grantor’s estate at death.
The Value of a Step-Up in Cost Basis
This shift is primarily due to the “step-up in basis” allowed for income tax purposes under Internal Revenue Code §1014. Assets included in a decedent’s gross estate generally receive an income tax basis adjustment to fair market value on that individual’s death, eliminating built in capital gains as well as depreciation recapture on rental real estate. By contrast, assets held in an irrevocable trust that are not included in the decedent’s estate do not receive this income tax step up adjustment. Instead, they retain their original carryover basis, which can result in significant tax liability upon a later sale of the asset.
For trusts holding highly appreciated assets, or assets expected to appreciate significantly over time, the loss of the step-up in basis can represent a substantial tax cost. For individuals who have already implemented irrevocable trusts in their estate planning, it could be useful to re-evaluate tax strategies to achieve estate tax inclusion for income tax purposes, particularly if doing so would not result in a corresponding estate tax burden.
Planning Strategies to Consider
Trust modification and termination planning techniques can, in appropriate circumstances, be used to achieve estate inclusion and preserve a step-up in basis for appreciated assets. Methods such as decanting or non-judicial settlement agreements may be implemented, as can granting a beneficiary a general power of appointment to trigger inclusion, while strategically timed distributions may also facilitate similar outcomes. However, these approaches must be undertaken with caution, as they may implicate the trust’s material purpose, require beneficiary consent or court approval, and raise additional fiduciary, tax, and creditor protection concerns. These strategies are best viewed as planning tools that require careful evaluation in light of the client’s overall estate plan and tax circumstances.
Balancing Estate and Income Tax Objectives
Ultimately, estate planning in a high estate tax exemption environment requires a more nuanced balancing of estate and income tax objectives. While irrevocable trusts remain valuable tools for asset protection, control, and multigenerational planning, their income tax implications can no longer be overlooked. Each situation must be evaluated based on the client’s asset composition, asset protection concerns, spendthrift needs, appreciation potential, estate size, and family objectives. While these types of trusts offer potential benefits, they also require careful analysis to ensure that the benefits outweigh the risks and that the client’s broader planning goals are preserved.
If you have set up and irrevocable trust or are a trustee or beneficiary of an irrevocable trust, it may be appropriate to review whether your current plan continues to make sense for your tax and estate planning objectives. Please contact Mara Peterson and Jeff Cohen to explore your planning options.
