What Readers Want to Know: Questions from My Email Inbox

A unique feature of Retirement Watch is readers can email questions directly to me. I read all the emails I receive and respond to each as best I can.

Questions often inspire articles in the newsletter. In this issue, I answer recent questions that I believe are of general interest but don’t require a full article to respond.

My parents held most of their assets in a revocable living trust. I inherited assets from the trust. What is the tax basis of those assets to me?

As most of us know, when assets are inherited through someone’s estate, the tax basis to the beneficiary usually is the fair market value on the date of the previous owner’s death, known as the step-up in basis. (There’s an exception I discuss in the answer to the next question.)

That’s an important tax benefit when assets have appreciated. The bene- ficiary can sell the assets right away and owe no capital gains taxes. The appreciation that occurred during the deceased owner’s holding period is never subject to capital gains taxes. Assets held in a revocable living trust during the grantor’s lifetime are treated the same way.

The assets in the trust are included in the grantor’s estate for computing federal estate taxes. For most of us, that won’t matter because the estate won’t face federal estate taxes. Then, beneficiaries of the trust receive the step-up in basis when the trust assets are distributed to them.

When the trust held financial assets in the custody of a financial services firm, such as a broker, it’s important for the beneficiary to notify the custodian of the step-up in basis after the assets are distributed. Otherwise, when the beneficiary sells an asset, the custodian’s report to the IRS might have a different basis. Most brokers have a standard form for the beneficiary to request the step- up basis on distributed assets.

The beneficiary generally needs to provide only a death certificate, the date of death and a list of the assets for which the basis should be stepped up. The step-up in basis doesn’t apply to assets held in an irrevocable trust. Those assets aren’t included in the estate of the deceased and continue the same basis they had when contributed to or purchased by the trust.

My father passed away early this year. The stocks and other financial assets in his estate declined in value while the estate was being settled and now are worth substantially less than when he died. Is our basis in the assets their value on the day he died?

For periods when asset prices are declining, the tax code has what’s called the alternate valuation date. The estate executor can elect that the assets be valued on the alternate valuation date, which is exactly six months after the date of death. The alternate valuation date was created because Congress didn’t think it was right to charge estate taxes based on a value that’s substantially higher than what they could be sold for currently.

The alternate valuation date also applies to the basis of assets inherited through the estate or a revocable living trust. If the lower asset value is used to determine the federal estate tax, it also is used to determine the basis of assets distributed to beneficiaries.

But the alternate valuation doesn’t apply unless the executor of the estate elects it. The executor must file a federal estate tax return on Form 706 and make the election on the form.

Otherwise, the value on the date of death is the basis of the inherited assets. Since few estates are subject to federal estate taxes, it makes sense this year for most executors not to elect the alternate valuation date. The benefi- ciaries who inherit the assets and sell them soon might receive deductible tax losses they can use on their indi- vidual income tax returns.

Can I provide for my pets in my will?

In most states, you can have enforceable provisions in your estate plan to provide for pets. The key is to find the mechanism that works for you and is valid in your state. Pets are considered property, so you can’t leave money or property directly to them. Other means are used to ensure they’re taken care of. The simplest approach is to name a pet guardian in your will.

You also can provide some instructions on the care of the pet, though the pet care provisions aren’t enforceable in all states. You also should provide funds to care for the pet, usually through a bequest to the guardian.

Or you can establish a pet trust that names a pet guardian as the beneficiary of the trust. The trustee can be either the beneficiary or a different person. You should fund the trust with enough money to ensure the pet has the level of care you want, including potential medical expenses.

The trust agreement can provide details about the level of care you want provided. Some trusts provide compensation for the pet’s guardian. The trust also should state what happens to money left in the trust after the pet passes away.

A third option is a written pet care agreement with a pet guardian. This is a legally enforceable contract that states how the guardian will care for the pet and how the pet’s needs will be funded. It might provide compensation to the guardian.

You need to work with an estate planner to determine which method is legally enforceable in your state and best accomplishes your wishes.

I set up an irrevocable trust some years ago. Some circumstances have changed, and I’m wondering if it’s possible to change some terms of the trust.

Though a trust says it is irrevocable, in most states there are several ways most of the terms can be changed. A non-charitable trust can be modified when the settlor (the person who created the trust) and all the benefi- ciaries (including minors) agree and the changes don’t violate a material purpose of the trust. This can be done without involving a court.

Also, a court can be asked to modify the trust. A court also will modify administrative provisions of the trust when it is convinced there has been an unanticipated change in circumstances. Also, a court often will order other changes when all beneficiaries agree on them, even if the trustee doesn’t agree. The court must be convinced the changes will satisfy the settlor’s intentions.

Of course, asking a court to modify the trust could be expensive. Another option is for the trustee to transfer the principal place of trust administration to another state. This usually is allowed after all beneficia- ries are notified. Changing the state in which the trust is located might change the laws that apply and make it easier to change the trust. Another option might be decanting, discussed in the next question and answer.

My estate planner mentioned trust decanting? What is that and should I consider making it available?

Trust decanting is another way to modify an irrevocable trust. It’s allowed in many states, though the details vary from state to state.

Decanting is when the trustee transfers the assets to a different trust. The assets and trustee are governed by the terms of the new trust agreement. Sometimes decanting is used to fix mistakes or ambiguous language in the old trust.

In many states, decanting also can be used to change the rules for distributions and make other substantive changes. In some states, beneficiaries can be added or removed through decanting. Unlike in a modification, the beneficiaries don’t have to agree to the changes.

The trustee can act on his or her own initiative. The trustee, however, must act as a fiduciary to the beneficiaries and must be impartial. A court might reverse a decanting if it determines the trustee took actions not allowed by state law or the trust agreement. A trust agreement usually must specifically provide that the trustee has the power to decant, but in some states the power is implied.

Keep in mind that either a modification or decanting of a trust could have estate, gift, and income tax consequences for the trust settlor and beneficiaries.

Do I have to tell my children they are beneficiaries of a trust I established?

Some trust settlors (or grantors) don’t want the beneficiaries to know about the trusts, at least not for a while. Trusts that beneficiaries don’t know about are called silent trusts. The general rule is that a trustee has to keep qualified beneficiaries reasonably informed. The Uniform Trust Code says beneficiaries must be informed within 60 days after a trust was created.

They should receive an annual report concerning the trust and have the right to re- quest a copy of the trust agreement. Beneficiaries also can demand an accounting of the trust. Disclosures are required because beneficiaries have a right to enforce the trust agreement and hold the trustee accountable, and they need information to do that.

In most states, these requirements can’t be modified by the trust agreement. But Delaware allows the disclosures to be made to a designated fiduciary of the beneficiary and disclosure to the beneficiary can be limited for a period of time.

South Dakota allows limited disclosure to beneficiaries for a period of time and allows disclosures to be made to a protector instead of a beneficiary during that time. But the general rule is that beneficiaries need enough information to be able to enforce the trust.