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one hi everybody welcome back to the tenth of an hour with griffin bridgers for today's episode episode 41 we're going to explore formula general power of appointment clauses in irrevocable trusts and how these can be used to bring about a step up in basis for trust assets now this covers a little bit of ground that we touched on way way back in episode six but we didn't really focus on the formula aspect then this time we're going to dig into that a little bit more now as always this presentation is not intended to substitute for legal or tax advice so when it comes to an irrevocable trust there's a step up in basis available for non-ird assets that are included in a decedent's gross estate so what do i mean by non-ird that basically means any asset other than something that is deferred taxable income so like an ira or 401k things like that those couldn't get a step up in basis to wipe out that out that income but any other capital asset that appreciates over time could potentially get that step up in basis the significance of that is that the heirs or the trust who receives that appreciated asset with a stepped-up basis could turn around and sell it and have no income tax gain and thus no income tax on the sale now when it comes to an irrevocable trust those assets are stuck in the trust there's only three ways in which those assets can be included in a decedent's gross estate the first two we're not going to really talk about today one is if you have a trust that's a marital trust over which a q-tip election has been made so at the surviving spouse's death those elected assets would be included in his or her gross state second that we're not going to discuss is if the decedent has previously gifted assets and trust but has retained control and or use of those trust assets or has given up control or use of those assets within three years of death and then finally the subject for today is if the decedent held a general power of appointment over the trust assets at death which doesn't have to be exercised or if there's not a general power of appointment if the decedent has exercised a non-general power in a way that springs what's called the delaware tax trap where the exercise of that power would reset the rule against perpetuitius period which governs the maximum term for trust now if you're confused by that don't worry we're going to focus on general powers of appointment today because the rule against perpetuities has been the bane of many a law student and even worse is the resetting of the perpetuities through the delaware tax trap no no not many people have the stomach for that and we can't really tackle that in six minutes but moving on the general power of appointment itself can be a valuable tool to harvest unused estate tax exclusion to get a step up in basis for previously gifted assets so if you look at a family as a whole if you look at each individual what you might see if you're a truly conniving tax planner is an 11.58 million exclusion for each member of that family tree that could somehow be harvested to get a step up in basis for enough assets so an example might be where a child has unused exclusion of 10 million and there's a trust over which the child is a beneficiary with highly appreciated real estate so could the child be given a general power of appointment over the trust assets to get a step up in basis and the answer is yes they could do so at the inception of trust so when it's drafted the settler of that trust could give them the general power of appointment that always works now sometimes as we're going to see you could give the child a general power of appointment midstream during the administration of the trust however after the child's death it's too late you could not give them a general power of appointment at that point you can't do tax planning that's backward looking after all events leading up to a taxable event have elapsed but the problem with this is how do you avoid using too much exclusion because as it's set right now the exclusion could go down in the future it's 11.58 million right now by 2026 it could be reduced by one half if we get a new administration in november it could be reduced even sooner so to avoid the situation where maybe you plan for a high exclusion and pull too many assets into a child's estate or a spouse's estate and cause unnecessary estate tax liability you can create what's called a formula general power of appointment so what this does is it applies the general power of appointment only to a fraction of the trust sufficient to use up the beneficiary's remaining estate tax exclusion so the formula might just say you have a general power of appointment over a fraction of the trust the dollar amount of which equals the remaining estate tax exclusion minus the taxable estate before taking into account trust assets so the big question with that too is that we're looking at this as a step up in basis but if there's depreciated assets ones whose basis is higher than their fair market value at the death of the beneficiary those could get a step down in basis and it would take away the trust's ability to use that tax loss so the big question is whether the trustee could allocate assets on a tax lot by tax lot basis when taking into account that general power of appointment or would the irs force a fairly representative allocation across the board maybe by fraction or otherwise that's kind of unsettled but the good news is that the formula itself has been blessed at least when it's drafted from inception there's a few private letter rulings out there on that but more often what happens now is that you have an existing irrevocable trust and was drafted back at a time when the exclusion was very low and nobody was doing this type of planning because you intentionally did not want to include assets of an irrevocable trust in somebody's gross estate not withstanding the availability of a step up in basis because the 40 or 45 percent back then estate tax rate is much higher than the 20 capital gains rate but you can now in some cases modify a trust to add a general power of appointment so the easiest way to do that would be in a situation where maybe you have a trust advisor or a trust protector who's expressly been given an amendment power under the trust that can be carried out in a way that creates a general power of appointment or maybe converts one from a limited to a general power but if you don't have such a a role or language in your trust the next best option is maybe that you could decant the trustee would have to guide that process and the good news with that is that it avoids beneficiary participation fully which is a an issue as we're going to see in the next point but the problem is depending on the state you're in you're decanting statutes it's unsettled as to whether it would allow the addition of a general power of appointment especially when there is a ascertainable standard discretionary distribution power you know really because decanting is driven by an analysis of the trustees distribution powers themselves and then finally you can look at an actual trust modification maybe by non-judicial settlement agreement or by court approval to add or convert to general power of appointment now this is an issue because it requires the consent of beneficiaries including unborn or unascertainable beneficiaries that have to be virtually represented so it can be hard to get that consent across the board and each beneficiary's consent and signature could result in gift tax liability to them it's also important to note that the irs may not respect a modification if it does not come from the highest state state court we've talked about that before but it kind of depends on the state and the uniform trust code and how that's analyzed on a broad basis and then finally trust modification has to be done in a way that respects material purposes of the trust and the addition of a general power of appointment as we've seen back in episode 6 could violate a material purpose of the trust which would void the modification now as we talked about in episode six it helps if the underlying trust maybe has some authorizing language where maybe the set laws intention is to save taxes to the greatest extent possible that may create a hook for the court or the non-judicial settlement agreement to latch onto to say hey this doesn't violate a material purpose even though these trust assets could be diverted to unintended beneficiaries through the general power of appointment but all of these are great options for getting that step up in basis where one might not have been intended when the trust was created and can be a great boon if you can actually go through the trouble of changing the trust to accomplish this goal as always if you have questions or topic suggestions you can email those to me at griffin.bridgers gmail.com thank you for listening to this episode of the tenth of an hour and i look forward to seeing you in the next one