Estate Planning, 13th Edition, Dalton
Introduction to Estate Planning
Basic Estate Planning Documents
Property Interests
Probate
Gift Tax
The Critical California Context: State vs. Federal
No California Gift Tax: Crucially, California does not have a state-level gift tax. A gift made by a California resident is subject only to Federal gift tax rules.
No California Estate Tax: California also has no state estate tax, meaning your planning focuses exclusively on the federal limits.
The Mechanics: Who Pays, What is a Gift?
Who Pays? The Donor (the giver) is responsible for the gift tax. The Donee (the recipient) generally does not owe income tax on the gift itself (though they pay income tax on any earnings the gift generates later, like dividends or interest).
Definition of a Gift: It is the transfer of property to an individual or entity for less than full and adequate consideration in money or money's worth. This includes money, real estate, stock, business interests, and even selling property below market value.
The Two Key Exclusions: The federal system provides two primary mechanisms to allow tax-free wealth transfer: the Annual Exclusion and the Lifetime Exemption.
A. The Annual Gift Tax ExclusionThis is the "free pass" your clients get every year to make gifts without any tax consequences or reporting requirement.
Key Feature: The exclusion is per donee, per year. A client can give the annual exclusion amount to an unlimited number of people (children, grandchildren, friends, etc.) without reducing their Lifetime Exemption or filing IRS Form 709.
Use-It-or-Lose-It: The annual exclusion does not roll over.
B. The Lifetime Gift and Estate Tax Exemption (The Unified Credit)This is the cumulative amount an individual can transfer during life (gifts) and at death (estate) without paying the 40% federal transfer tax.
How They Interact: Any gift to a single donee in a year that exceeds the Annual Exclusion is a Taxable Gift. This amount does not trigger an immediate tax payment, but it reduces the Donor's remaining Lifetime Exemption.
Example: In 2025, a client gives a child $50,000. The first $19,000 is covered by the Annual Exclusion. The remaining $31,000 is a Taxable Gift that reduces the client's $13.99 Million Lifetime Exemption.
Filing Requirement: Any time a gift exceeds the Annual Exclusion, the donor must file IRS Form 709 to report the gift and track the reduction in their Lifetime Exemption, even if no tax is due.
Advanced Planning Consideration: Basis Step-Up
The most important tax trap you must counsel clients on is the Lost Step-Up in Basis:Gifted Asset: When a client gifts a highly appreciated asset (like stock or real estate), the donee receives the Donor's original, lower cost basis (carryover basis). If the donee later sells the asset, they face a potentially large capital gains tax.
Inherited Asset: If the same client holds the appreciated asset until death, the beneficiary receives a new basis equal to the fair market value at the date of death (stepped-up basis). This often wipes out all capital gains accrued during the decedent's lifetime.
Your Rule of Thumb: Counsel your clients to gift assets with high basis (or cash) to use their exclusions, and to hold assets with low basis (highly appreciated) to get the basis step-up at death.
Estate Tax
The Federal Estate Tax is not a tax on the heir, but a tax on the decedent's right to transfer property at death.
The Unified Transfer Tax System (The Big Picture)
The estate tax is fundamentally linked to the Gift Tax through the Unified Credit.
The Exemption Amount: The most critical number. This is the total value an individual can transfer (via gifts during life and assets at death) free of federal transfer tax.
2025 Exemption: For example, in 2025, this amount is $$$13.99 million per individual (adjusted annually for inflation).
The Gift Tax Connection: Taxable gifts made during life (gifts above the Annual Exclusion) reduce the Exemption Amount available at death. They are a single, unified system.
Gross Estate and Taxable Estate
Gross Estate: This includes the fair market value (FMV) of everything the decedent owned or controlled at the date of death. This includes obvious assets (real estate, cash, stocks) but also assets passing outside of a will or trust, such as:
Life insurance policies where the decedent was the owner.
Retirement accounts.
Assets held in revocable trusts.
Taxable Estate: This is the Gross Estate minus allowable deductions. Key deductions include:
Marital Deduction: An unlimited deduction for assets passing to a U.S. citizen surviving spouse. This is why a married couple can defer all estate tax until the second death.
Charitable Deduction: An unlimited deduction for assets passing to qualified charities.
Debts, funeral expenses, and administrative costs.
Tax Rate: The top marginal rate for the Federal Estate Tax is currently 40%.
Key Planning Opportunities for Married Couples
Portability: The surviving spouse can elect to claim the deceased spouse's unused exemption (known as the Deceased Spousal Unused Exclusion - DSUE). This must be elected on a timely filed federal estate tax return (Form 706), even if no tax is due.
Marital Deduction & Deferral: Most married couples structure their estates to use the Unlimited Marital Deduction to defer all estate tax until the death of the second spouse. Proper planning then focuses on utilizing both spouses' exemptions.
The California Context
Here's a critical fact for your California clients:
California has NO State Estate Tax or Inheritance Tax.
While this is great news, be aware of two other crucial California-specific tax areas that frequently drive estate planning:
California Property Tax (Prop 19): Transfers of real estate to children or grandchildren may trigger a property tax reassessment, drastically increasing property taxes unless strict rules (related to principal residence and capped value) are met. This is often a greater concern than the federal estate tax for the average California client.
Capital Gains Tax (Basis Step-Up): Inherited assets receive a "step-up in basis" to the fair market value at the date of death. This is one of the most powerful tax benefits in the U.S. tax code, eliminating all accumulated capital gains on appreciated assets.
Transfers: Life and/or at Death
Trusts
I. Defining the Trust Relationship
A. The Core Concept
A trust is a fiduciary arrangement that allows one party (the Grantor) to transfer assets to a second party (the Trustee) to hold and manage on behalf of a third party (the Beneficiary). It is essentially a separate legal entity created by a written Trust Instrument (or Trust Agreement) to govern the management, conservation, and eventual distribution of assets outside of the public and often time-consuming probate process.
Key Division of Ownership: The legal title (held by the Trustee for management) is legally separated from the equitable or beneficial title (held by the Beneficiary for enjoyment). This separation is the legal backbone of all trusts.
B. The Three Essential Parties and Their Roles
A valid trust requires three distinct roles (Grantor, Trustee, and Beneficiary). While one individual can fill all three roles initially in a revocable trust, CFP professionals must understand the separate legal functions each role performs.
Grantor (Settlor or Trustor):
Role: The architect and funder of the trust. This person creates the legal document and transfers initial assets into it (funding).
Function: Defines the trust's entire operating structure, including naming beneficiaries, specifying distribution standards (e.g., health, education, maintenance, and support—the "HEMS" standard), and appointing successor trustees. The Grantor may create the trust during life (a Living Trust or inter vivos trust) or at death via a will (Testamentary Trust).
Trustee:
Role: The manager of the legal title to the trust assets. The Trustee accepts the responsibility to carry out the Grantor's instructions.
Function: The Fiduciary Duty. This is paramount. The Trustee must act solely in the best interests of the beneficiaries, adhering to two core responsibilities:
Duty of Loyalty: The Trustee must avoid all conflicts of interest and cannot self-deal.
Duty of Prudence: The Trustee must manage and invest the trust assets using the standard of a "prudent investor," which requires diversification, reasonable risk assessment, and minimizing unnecessary costs. Many states adhere to the Uniform Prudent Investor Act (UPIA).
Duty to Inform/Report: The Trustee must keep beneficiaries reasonably informed about the trust and its administration, typically requiring annual statements.
Beneficiary:
Role: The person or entity that receives the benefits of the trust assets (income or principal).
Types:
Present Beneficiary (Income): Receives the current income generated by the trust assets (e.g., dividends, interest).
Remainder Beneficiary (Principal): Receives the principal (corpus) of the trust when the trust ultimately terminates (e.g., upon the death of the income beneficiary or reaching a specified age).
Distribution Standards: Distributions can be Mandatory (the trustee must distribute) or Discretionary (the trustee may distribute based on the Grantor's guidance, such as the HEMS standard).
C. Requirements for Trust Formation
For a trust to be legally recognized and enforceable, four primary elements must be present:
Identified Parties: A clearly identified Grantor, Trustee, and Beneficiary.
Intent: A clear expression of the Grantor's intent to create a trust (usually via a formal, written trust instrument).
Trust Property (Res): There must be an asset, however small, legally transferred to the Trustee. Without property, there is no trust to manage.
Lawful Purpose: The purpose of the trust cannot be illegal, contrary to public policy, or impossible to achieve.
III. Primary Uses and Benefits in Financial Planning
A. Probate Avoidance and Privacy (Revocable Trusts)
RLTs are the most common estate planning tools because they avoid the often slow, expensive, and public nature of the probate court. Funding the trust (retitling assets like brokerage accounts and real estate into the name of the trust) is the critical step that ensures the trust agreement, and not the Will, governs distribution.
B. Management During Incapacity (Revocable Trusts)
A trust is an essential tool for incapacity planning. Unlike a simple Durable Power of Attorney (POA), which may be rejected by some financial institutions, a funded RLT immediately grants the named Successor Trustee full legal authority over the assets held in the trust. This provides seamless financial management if the Grantor becomes unable to manage their own affairs.
C. Asset Protection (Irrevocable Trusts)
Used for advanced planning to shield assets from professional liability, future bankruptcies, or high-risk business ventures. This protection is often achieved using a Spendthrift Provision, which restricts a beneficiary from assigning or transferring their interest in the trust to a creditor.
D. Tax Planning (Irrevocable Trusts)
For ultra-high-net-worth clients, Irrevocable Trusts are non-negotiable for reducing the transfer tax burden:
ILITs (Irrevocable Life Insurance Trusts): By keeping life insurance proceeds (which are income tax-free) out of the insured's taxable estate, an ILIT ensures maximum liquidity for heirs to pay potential estate taxes without having to liquidate other assets.
GRATs (Grantor Retained Annuity Trusts): A powerful technique where the Grantor transfers assets to the trust but retains the right to an annuity payment for a term of years. Any appreciation left in the trust at the end of the term passes to beneficiaries gift-tax free.
E. Control and Conditional Distribution
Trusts are the only way for a Grantor to exert control over assets well beyond the grave. This is vital for:
Protection of Minors: Ensuring children only receive assets at a financially responsible age (e.g., fractional distributions at 25, 30, and 35).
Special Needs Planning: Creating a Special Needs Trust (SNT) that allows a disabled beneficiary to receive supplementary financial resources without jeopardizing their eligibility for essential government benefits (like Medicaid or Supplemental Security Income/SSI).
Charitable Giving
Unlimited Marital Deduction
Life Insurance in Estate Planning
Special Elections and Postmortem Planning
Generation Skipping Transfers
Basic Estate Plan