Blended Family, State Estate Tax, and a Charitable Bequest

Outright to Dana fails three ways:

1. It wastes Harold's $2 million state exemption. With no state portability, the exemption is use-it-or-lose-it. At Dana's death, her estate could include roughly $9.2 million with only her $2 million exemption, exposing about $7.2 million to state estate tax. Depending on the state rate, that could be several hundred thousand dollars.
2. It does not guarantee the children receive the remainder. Dana can change her will, remarry, or face creditors. Harold's first-marriage children have no enforceable claim.
3. It creates a control problem, not just a tax problem. Harold's goal is income and security for Dana, remainder to his children. Outright ownership gives Dana the remainder.

The counterargument is real: outright ownership gives Dana a step-up in basis at Harold's death and maximum flexibility. A bypass trust funded with low-basis stock would forgo that second step-up. The planning must weigh state estate tax saved against capital gains cost, which is why the asset chosen to fund the bypass trust matters more than the trust itself.

A three-part structure:

1. Credit shelter (bypass) trust funded with $2 million of high-basis or non-IRA assets to use Harold's state exemption. Do not fund it with the low-basis stock if avoidable; the stock inside the bypass trust will not get a second step-up at Dana's death. Fund it with cash, the residence to the extent of Harold's interest, or insurance proceeds. If the only available assets are low-basis, compare the state estate tax saved (roughly the state rate times $2 million) with the capital gains cost on the lost step-up.
2. Marital/QTIP trust for the remainder, with Dana receiving income and principal for life and the children as remainder beneficiaries. This qualifies for the marital deduction and keeps the children's remainder enforceable.
3. Irrevocable life insurance trust (ILIT) to hold the $1.0 million policy, with Dana as beneficiary and the children as remainder. Moving the policy out of the revocable trust removes it from Harold's estate, but the three-year rule applies if he dies within three years of transfer. Use the ILIT proceeds to replace the wealth consumed by Dana's support and to fund the bypass trust with cash rather than low-basis stock.

Charitable piece: name the alma mater as beneficiary of $500,000 of the traditional IRA, not the stock. The IRA is income in respect of a decedent and would be taxed to the children; a charity pays no income tax. This also preserves the step-up on the stock.

Capacity is the threshold issue. A will or trust amendment signed when capacity is questionable is an invitation to litigation. Steps:

• Obtain a contemporaneous capacity evaluation from a physician or neuropsychologist before execution; document it.
• Execute a durable power of attorney and health care directive now, naming an agent Dana and the children can live with, or a neutral party.
• Consider a revocable living trust to avoid probate and to name a professional or corporate trustee.

Family conflict: the children and Dana have adverse interests in the remainder. Mitigate by:

• Recommending that Dana have her own independent counsel.
• Using a neutral or corporate trustee rather than Dana or a child.
• Writing a letter of wishes that explains Harold's intent without creating enforceable ambiguity.
• Holding a family meeting to explain the structure, not to negotiate it.

If Harold cannot participate meaningfully, do not proceed with substantive changes on the strength of a prior conversation. Protect the existing plan first.