Source: http://www.trainottilaw.com/change-in-circumstances-can-require-unwinding-of-out-of-date-tax-planning/
Timestamp: 2019-04-25 22:29:53+00:00

Document:
Stuff happens. An estate plan that looked good 10 years ago may not be good today. Given the significant increase in the “applicable exclusion amount” for federal wealth transfer taxes up to $11,180,000 for an individual, as well as the federal and California combined highest capital income tax rates (federal 20% and 3.8% + CA 13% = 36.8%), the old mantra of “better to avoid estate tax now even if it means deferred capital gains later” may now be flat-out wrong for some clients that will not be subject to an estate tax rate of 40%. That invites discussion of the need to “unwind” one or more of the techniques implemented as part of a prior estate plan.
Irrevocable trusts such as bypass trusts established on the death of a spouse or asset freezing trusts established to freeze assets values of highly appreciating assets on the date of the transfer rather than on the death of parents have been established to avoid the paying or reducing the higher estate tax rate. The cost would be having to pay capital gain taxes since there would be no step up in basis on the death of the parent. Let me illustrate this below in a simple example.
Example. Assume a parent established a grantor trust 10 years ago for his or her children of rental property that was worth $2.5 million and $0 basis because it was fully depreciated. Today the property is worth $5 million on the parent’s death. The children want to sell the rental property to purchase other non-real estate investments assets. Today, there would be no estate tax owed on the parent’s death, but there would be a significant capital gain tax ($5,000,000 x 36.8% = $1,840,000). If the parent did not establish the grantor trust there would have been a stepped up to the $5 million and no capital gain tax owed!
California has recently modified Probate Codes §§ 15403 and 15404 to allow irrevocable trusts such as bypass trusts established on the death of a spouse or asset freezing trusts established to freeze assets values of highly appreciating assets on the death of parent to be modified and/or terminated based upon beneficiaries’ consent. Probate Code §15403 is used when the parent is deceased but his or her spouse and or children are still alive. Probate Code § 15404 is used when the parent who created the irrevocable trust is still alive and so are the beneficiaries. Probate Code § 15404 can be used without having to go to court under certain circumstances compared to Probate Code §15403. In the above example, the parent and children could terminate the grantor trust under Probate Code § 15404 without having to go to court.
There are other planning strategies that can also avoid the impact of potential capital gains depending on the nature of the irrevocable trust and what powers or rights were drafted in the documents. I recently wrote an article dealing with a bypass trust that gave a surviving spouse a limited power of appointment. The surviving spouse can exercise the limited power of appointment in order to give to her children a general power of appointment that would cause a step up in basis in the above example on the death of the surviving spouse. This type of planning has been approved by the IRS called a “Delaware Tax Trap” under IRC §2041(a)(3).

References: §15403
 § 15404
 § 15404
 §15403
 § 15404
 §2041