By McKenzie Paulsen.
The New Wave: Proposed Changes for Inheriting a Decedent’s Estate
A new wave of laws is on the horizon for estate planning. What are these new waves? The most prominent changes are the proposed sunset of the increased federal estate tax exemption and the removal, or partial removal, of the basis reset. These changes may affect today’s generation and could have a ripple effect on future generations. For estate planners, this means there is an increasing need for flexible estate planning that can ride the wave of new laws.
Today, individual estates are subject to various taxes, such as the federal estate tax and the federal gift tax. The most prominent tax is the federal estate tax, which is a tax on your right to transfer property at your death. The Tax Cuts and Jobs Act increased the federal estate tax exemption to new heights. Currently, to be subject to the federal estate tax, an individual’s estate must be greater than $13,610,000. However, in 2025, the federal estate tax exemption is proposed to “sunset” to approximately $5,490,000. If the federal estate tax exemption does sunset, far more individuals will be subject to the federal estate tax.
Additionally, the proposed American Families Plan will affect another important estate planning tool. The plan would remove, or partially remove, the basis reset of an asset. The basis reset allows for a qualifying inherited asset’s original cost basis to be adjusted to fair market value at the decedent’s death. For example, imagine Tom, the decedent, buys a home for $100,000 (the original cost basis). When he passes, Kate, his daughter, inherits the house. The house is now worth $500,0000 (the fair market value). If Kate sells her inherited property under the current estate law, Kate will receive a step-up in basis from the original basis to the fair market value of the property. With the basis reset, Kate would not be subject to tax on the $400,000 difference between the original basis of $100,000 and the fair market value of $500,000 at the time of Tom’s passing. Without the basis reset, Kate would incur a tax liability on the $400,000 difference. As exemplified, the basis reset can greatly reduce tax liabilities for an individual selling an inherited asset.
Furthermore, for individuals in Arizona, a community property state, the basis reset is an even more powerful tool as individuals receive a full basis reset not only at the death of the decedent but also at the death of their spouse when married. The effects of removing the basis reset are even more prominent in community property states.
Planning for a New Wave of Laws: Promoting Flexible Estate Planning
Although the future of estate planning is unknown, estate planners should begin considering alternative methods to permit flexibility in their clients’ estate planning. There are several planning mechanisms that lawyers may implement that can alleviate the impending estate planning concerns.
First, estate planners may consider implementing the “flipping the switch” method. When creating a trust, a trust can be either a grantor or a non-grantor trust. A grantor trust treats the grantor as the owner for any income taxes incurred by the trust. Alternatively, a non-grantor trust pays taxes directly from the trust rather than the grantor. The “switch” is a clause within the trust agreement permitting the trust protector to “switch” the grantor trust into a non-grantor trust, which alleviates the tax burden on the grantor.
Why is the “switch” a useful tool? Although a grantor trust may allow tax-free growth of an individual’s wealth, there is also a risk of incurring high capital gains taxes. For example, a grantor may decide to sell their business, which is held in a grantor trust, for twenty million dollars. The capital gains taxation could be massive and cause an undue burden on the grantor. To combat this potential concern, using a “switch” by a trust protector could protect the grantor.
Second, if individuals fear new tax burdens but want to maintain the trust status as a grantor trust, reimbursement clauses could resolve some impending concerns. Similar to “flipping the switch,” reimbursement clauses allow a trustee of an irrevocable grantor trust to “reimburse” the income tax liabilities stemming from the trust’s assets to the grantor.
The use of reimbursement clauses allows for vast flexibility as future legislation evolves. However, they also come with risks. Estate planners need to be weary because the use of reimbursement clauses could cause the inclusion of the trust into the decedent’s estate. Under Rev. Rule 2004-64, in order to avoid inclusion under 2036(a)(1), the reimbursements cannot be mandatory.
However, to avoid inclusion, six states have specific statutes permitting reimbursement clauses, including Colorado, Connecticut, Delaware, Florida, New Hampshire, and New York. Other states, including Arizona, Idaho, Illinois, Iowa, Texas, Kentucky, Maryland, Massachusetts, Montana, North Carolina, Pennsylvania, Texas, and Virginia, have permitted creditor protection for the use of reimbursement clauses. To further protect from inclusion, estate planners should make sure no prior agreements for reimbursements are made and use this tool for emergency circumstances only.
Third, the use of spousal lifetime access trusts could further protect an individual’s assets. A spousal lifetime access trust (“SLAT”) is a form of irrevocable trust that is “created by one spouse (trustmaker spouse) for the benefit of the other (beneficiary spouse).” SLATs help provide creditor protection and can reduce the value of one’s estate. However, SLATs are irrevocable, and the implications should be discussed prior to their creation.
Lastly, individuals should also seek to use their annual gift exemptions. Currently, an individual can give $18,000 per donee. These gifts are not included in one’s federal estate for estate tax purposes and thus can help reduce an individual’s taxable estate.
Overall, there may be major changes to the laws and regulations for estate planning, such as the partial removal of the basis reset and the sunset of the federal estate tax exemption. As estate planners prepare for a new wave of inheritance laws and regulations, they should encourage their clients to act now and create the flexibility their clients desire.
By McKenzie Paulsen
J.D. Candidate, 2025
McKenzie is currently a 2L from West Des Moines, Iowa, interested in trusts & estates law. Prior to law school, she attended the University of Iowa. While at Iowa, she followed many of her passions, including the arts, entrepreneurship, and community support. She enjoys hiking, trying new recipes, and traveling in her spare time.