Robert Lamm
Within the last year, there has been a shift in the way some estate planning attorneys are drafting their trusts. The American Taxpayer Relief Act of 2012 (ATRA), passed in January 2013, enabled a husband and wife to benefit from each other’s unused estate tax exemption amount without having to draft complex estate planning documents.
Previously, to minimize the payment of estate tax upon the death of the surviving spouse, estate planning attorneys advised their clients to use “bypass trusts” to be funded with assets equal to the predeceased spouse’s estate tax exemption amount available at his or her death. The surviving spouse could be a beneficiary of the bypass trust and potentially even manage the trust assets by serving as its trustee. If properly drafted, the value of the trust’s assets would not be included in the surviving spouse’s gross estate on his or her death because the bypass trust owns the assets—not the surviving spouse. In many cases, the end result is that no estate tax is due upon the death of the surviving spouse. ATRA eliminates the necessity of bypass trusts in this regard by allowing the surviving spouse to use the deceased spouse’s unused exemption. This rule applies whether or not the couple has a trust at all!
Sounds fantastic, right? Maybe. GLENT. EICHELBERGER and BRIAN P. TEAFF, in their article titled “Bypass Trusts: Obsolete Bygones or Too Good to Pass Up?” which can be found in the Nov 2013 Estate Planning Journal (WG&L) provide a comprehensive list of reasons as to why you may or may not want to have a bypass trust.
Here are some reasons why they think you may still want a bypass trust:
- Assets in a bypass trust can appreciate in value outside of the surviving spouse’s estate free from estate and gift tax.
- Assets of a bypass trust are generally protected from the surviving spouse’s future creditors.
- By forcing the creation of a bypass trust, the deceased spouse can protect against the surviving spouse “redirecting” the assets.
- For a married couple with significant wealth, trust planning is still necessary to achieve generation-skipping transfer (GST) tax efficiency because the GST exemption is not portable under ATRA. Planning to preserve 100% of the available GST exemption is important to the long-term planning for grandchildren. Over the long term, the proper use of both spouse’s GST exemption can prove to be one of the most valuable long-term features of an estate plan for a wealthy family. Although a wealthy couple may wish to avoid complexity, they will surely appreciate the value of avoiding estate taxes for multiple generations.
They also discuss reasons why you may not want a bypass trust. They are:
- Most assets included in the surviving spouse’s estate will receive a second step-up in basis for federal income tax purposes on such surviving spouse’s death (the first step-up occurred on the death of the first spouse). Conversely, assets funded into a bypass trust receive a step-up in basis only on the death of the first spouse. Because the estate tax rate will almost always be greater than the capital gains rate, however, the advantage of the additional step-up must be weighed against the estate tax liability that occurs as a result of the assets being included in the surviving spouse’s estate.
- Bypass trusts introduce additional administrative complications to the surviving spouse who generally prefers to maintain “business as usual.” For example, bypass trusts require the filing of annual tax returns and trust accountings, which the surviving spouse may wish to avoid.
My take on all of this is that you should not let the tax tail wag the dog. In most cases, people should have a trust if for no other reason to avoid probate at their demise. The other reason is that the “redirection” of assets is the cause of litigation which in most cases will deplete the entire estate. A bypass trust, at least, protects half of the estate.
