Should You Bypass the Bypass Trust? Establishing a living trust is a key element of many estate plans, and most of these trusts mandate the creation of an irrevocable bypass trust upon the death of the first spouse. A bypass trust, sometimes called a B trust or credit shelter trust, is funded with assets from the deceased spouse’s estate. If structured properly the surviving spouse can receive the income from these assets and have limited rights to invade the trust corpus. On the death of the surviving spouse the assets in the bypass trust are not included in the estate of the surviving spouse. This strategy is used to either eliminate or minimize estate tax upon the second death. Now, with the passage of the American Taxpayer Relief Act of 2012, the creation of a bypass trust on the first death may be unnecessary.
Thanks to the American Taxpayer Relief Act of 2012, everybody has $5,250,000 of estate tax exemption which means that each of us can leave $5.25 million to our heirs estate tax free. For a married couple the amount is $10,500,000. On top of that there is a portability feature which says that if the first spouse doesn’t use the entire estate tax exemption, the balance left over can be transferred to the surviving spouse.
Suppose Bill and Betty Smith had an estate of $8 million dollars, and Betty passes away before Bill. Her share of the estate is $4 million. Her estate uses $4 million of the $5.25 million exemption leaving $1.25 million in unused exemption. If he does not remarry, this unused balance can be added to Bill’s exemption so that when he dies he has $6.5 million he can leave to his heirs free of estate tax. In this example they do not need to create a bypass trust to eliminate estate taxes. The exemption and portability covers all of their estate tax liability.
Many living trusts were written when the estate tax exemption was much lower and the living trust mandated the establishment of a bypass trust upon the first death. This was necessary in order to minimize estate taxes. But with this new exemption amount and portability you may find that you don’t need to have a bypass trust created on the first death. However, there may be reasons other than estate tax minimization for the creation of a bypass trust so we recommend that you meet with your attorney to determine if the language in your trust should allow for more flexibility. We also suggest that you discuss your specific tax issues with a qualified tax advisor.
If you need some help understanding the options in your particular situation, please don’t hesitate to call us at 408-551-6100 or toll free 800-927-8314 and ask to speak with one of our financial advisors.
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