Estate Planning is always a difficult but necessary step to complete in your financial plan. Couple that with major tax implications, and you will quickly see why it is important to keep your estate plan updated. Many owners and families often ask whether they need a trust. I have written about trusts before, but mainly from the perspective of a cleaner estate plan post-death. A properly executed trust can certainly improve the post-death process, but there are also reasons why a trust could save an estate thousands in taxes as well. While the specifics may depend on your situation, creating a Community Property Trust could significantly change your tax situation.
Key Takeaways
- Most Kentucky families are below the federal estate tax threshold ($15M per person in 2025), but capital gains taxes can still impact appreciated assets. This means trusts remain valuable not only for estate tax avoidance, but also for managing and minimizing capital gains exposure for surviving spouses or heirs.
- Married Kentuckians with highly appreciated assets or businesses should consider a Community Property Trust, which can significantly reduce capital gains taxes for a surviving spouse and even replace a Living or Revocable Trust. However, this requires careful planning due to potential complications like divorce, liquidity, and creditor issues.
- Community Property Trusts can help Kentucky married couples minimize taxes and maximize flexibility by providing a full step-up in cost basis at the first spouse’s death, making them a valuable estate planning tool for those with significant capital gains.
What is the role of a Trust?
If you have previously worked with an estate planning attorney, you have probably been asked about setting up a trust. Based on my anecdotal experience, most people don’t know a lot about a trust. To be fair, a “trust” is more of a category than a noun. It would be similar to someone asking if you want to buy “investments”. The answer would certainly depend on what type of investment (or trust) they are referring to. There is a nearly infinite number of trust types designed to help people avoid probate, control assets after their death, protect dependents, give to charity, save on taxes, and other reasons.
In the last decade or so, the general sentiment of trusts has become less important if the trust is built primarily for tax purposes. Since 2017, the Federal Estate Tax Exemption has been over $10 million and is set for $15 million for 2025. In other words, for single people with less than $15 million or couples with less than $30 million, there should be no federal estate tax obligations. Once you surpass these assets, then more complex trusts are certainly relevant, whether that is through Irrevocable Trusts, Charitable Remainder Trusts, Grantor Retained Trusts, and so on.
Most families and small businesses in Kentucky do not need to worry about estate tax. However, that may not be the only tax that needs to be paid. This is when capital gains tax enters the scene. Capital Gains Tax is a government tax on profits (gains) from investments. If you purchased $250,000 of Nvidia in a brokerage account and it grew to $1,000,000 a year later, then your $750,000 gain likely could be subject to Capital Gains Tax.
As wealth increases, many people and especially business owners, accrue capital gains that become a tax problem. It could lead many to avoid selling investments to avoid recognizing those gains and owe taxes. This creates a significant issue if or when a spouse passed away. Even if the total estate may be under $30 million and therefore not owe estate tax, it is entirely reasonable that there are still five or six figures of potential capital gains tax that must be paid. Without the proper structure in place, a surviving spouse could be forced to sell those assets and incur those capital gains tax.
Inheriting Taxes
Inheriting taxes can be a major issue in estate planning. Typically, when someone passes away, their beneficiaries can receive a step up in cost basis for their assets. A cost basis is the total amount paid for the investment, so in our earlier example the cost basis for the Nvidia investment would be $250,000. This would generally apply to assets that could be subject to capital gains (homes, brokerage accounts, rental properties, etc.). This would not include assets in a 401k, IRA, etc. since those are generally not subject to capital gains tax.
For married couples with Jointly Held Accounts, the surviving spouse in Kentucky generally receives one half of a step up in those assets/accounts. Continuing our example, if a jointly held brokerage account had that $1,000,000 in Nvidia stock, the cost basis would only increase from $250,000 to $625,000 at the death of the first spouse. This is the estate issue relative to capital gains tax, since a single person would have received the full step up to $1,000,000 while the surviving spouse still has $375,000 in capital gains.
To solve this problem, you must understand the difference between common law property versus community property. Each state determines how assets within the state are categorized. Currently nine states in the US are considered community property states, where spouses essentially split evenly all assets acquired during the marriage, regardless of what account it is in. There are an additional five states that allow you to opt-in to community property, and importantly one of the five states includes Kentucky. Since 2020, this means that Kentuckians can create a Community Property Trust where the main significant benefit, is that upon the death of the first spouse the trust can receive a 100% step-up, not only 50%.
Community Property Trust
There are a lot of caveats to community property and common law property, including the trusts around it or property in multiple states. However, in its simplest explanation, married people in Kentucky with significant capital gains should explore a Community Property Trust. From both estate and tax perspectives, many prefer to minimize the tax burden on a surviving spouse, especially in the event of an untimely death.
Creating a properly drafted Community Property Trust can work closely with or even replace a Living Trust or Revocable Trust. For business owners, this could be one of the largest tax savings within estate planning. Many business owners who sell their business are subject to capital gains, usually at a 20% tax rate. For those currently running a six or seven-figure company, chances are the valuations are well into the millions. For those who built their company from the ground up, their cost basis may be next to nothing. At the very least, your spouse trying to sell your million-dollar business could realistically create hundreds of thousands in capital gains tax.
There are limitations to trusts that always need to be considered, especially around Community Property Trusts. Situations can complicate very quickly in divorces when community property is involved. Make sure to understand what changes for assets that go into (or out of) the trust, whether that be related to liquidity, creditors, or access to funds after death. Work with a quality estate planning professional to understand the risks of certain trusts and make sure that any trust you create fits your specific situation.
Death and Taxes
Ultimately, Community Property Trusts in Kentucky could be a great way to solve the issue of stepped-up basis for married couples. In a perfect world, once the first spouse passes away of old age, the second spouse has as much flexibility as possible while minimizing the tax implications. Especially with how complicated financial life is now, married couples with capital gains may want to explore if a Community Property Trust could improve their estate plan.
TC Falkner 