The New Tax Law makes Revisiting old Estate Plans Critical while creating an opportunity for first time estate plannersRead More
Due to recent changes in estate tax laws, the bypass trust may not produce the savings it once did. On the contrary, it may cost families more. The bypass trust, also known as the A/B Trust, was once a popular estate planning tool. Consequently, many estate plans - especially those done prior to 2000- may contain one of these trusts. If this sounds familiar, you may consider updating your trust. It goes without saying that other life changes (like grandchildren) may also necessitate an update to your Estate Plan.
Bypass trusts were originally designed to prevent the estate of the surviving spouse from having to pay estate tax. They work like this: when the first spouse passed, and left everything to the surviving spouse, the surviving spouse's estate may have exceeded the limits of the estate tax exemption. A little bit of clarification here: currently, if one dies with more than $5.43 million in assets, they will have to pay taxes on any assets exceeding $5.45 million. If you die with less than $5.45 million, no estate taxes are owed. The estate tax number has been significantly lower in past years, and the bypass trust was a way to work around that.
The prevailing thought in the heyday of A/B Trusts (aka bypass trust aka credit shelter trust) was to split the estate that exceeded the estate tax exemption between spouses. Then, a trust would be created for each spouse that would “shelter” the first exemption amount in the estate of the first spouse who passed away. The trust income would be paid to the surviving spouse and the trust principal would be available at the discretion of the trustee if needed by the surviving spouse. Since the surviving spouse did not control the distributions of principal, the trust funds were not included in the surviving spouse’s estate at the time of death and would not be taxed. Sound complicated? Luckily some in congress thought so too.
In 2013 estate tax law changed dramatically, and consequently very few people are subject to federal estate taxes. Current law (2016) allows the first $5.45 million in an estate to be exempt from federal estate taxes, so between a husband and wife there would be no estate tax if their estate is less than $10.90 million. The estate tax is “portable” between spouses, which in effect, accomplishes the same purpose as the bypass trust. So, if the first spouse to die does not use all of his or her $5.45 million exemption the estate of the surviving spouse may use it (providing the surviving spouse makes an “election” on the first spouse’s estate tax return).
So what's the real disadvantage to the bypass trust?
The original bypass trust does not allow the surviving spouse to have complete control over the assets in the trust. The ability of the surviving spouse to use trust assets is limited, and requires the filing of accountings and separate tax forms. In addition, problems can occur if the trust generates income that is not passed to the beneficiary. This can lead to additional taxes.
A bypass trust can also cost more in capital gains taxes than it saves in estate taxes. When someone passes away, his or her assets receive a “step-up in basis”. In a bypass trust, assets do not receive a “step-up in basis” because the assets are passing outside of the spouse’s estate. If those assets are sold after the death of the surviving spouse, his or her heirs may have to pay higher capital gains taxes than if they had inherited the assets directly.
That being said, a bypass trust is still useful in some circumstances. If the estate is larger than the current tax exemption allows, the bypass trust continues to be a good way to shelter your assets from the estate tax.
For questions about bypass or A/B trusts, or to see if you would benefit from an updated Estate Plan, call our Walnut Creek Estate Planning Firm at 925-322-1795 to schedule a consultation.
When is it necessary to update your Estate Plan?
So you've already done the responsible thing and put together your estate plan. But several years have passed and life circumstances may have changed. So when is it necessary to go back to your attorney to update your will, trust, power of attorney, and healthcare directive? If you can answer yes to any of the following questions, I recommend an update:
Factors that May Impact your Estate Plan
Have there been any births in your family?
Have there been any deaths?
Have you gotten divorced?
Have you gotten married or remarried?
Have you been diagnosed with a new health condition?
Has your net worth significantly changed?
Have you added large assets to your estate which are not yet in your trust?
Have you sold or bought a business?
Have you moved to a different state or country?
Are there any new tax laws that will affect your estate taxes?
What will your attorney need to revise your Estate Plan?
Your current original estate planning documents, including your Financial Power of Attorney, Advance Healthcare Directive, Will, and Trust
Copies of deeds or other asset ownership information (for example: do you own a gold mine? One of my clients had one in South Africa!)
Should I update my Estate Plan with the attorney who drafted the original?
If you did your will or trust a number of years ago, consider establishing a relationship with a new, younger Estate Planning attorney. I recommend this for two reasons:
A younger attorney is more likely to be around to assist you with questions and concerns in the future. You will also have the opportunity to build a lasting relationship with someone you trust to assist your family when you pass.
A second pair of eyes never hurts. Even if you choose to stick with your original Estate Planning lawyer, consider letting another attorney in the field double check your plan. I've had many potential clients bring me their current Estate Plans to review. Some are well done, and very little time is needed to make updates. Some estate planning documents, on the other hand, are poorly worded and confusing, which can lead to unnecessary estate litigation down the road.
Updating your Estate Plan to make sure it is still relevant can be just as crucial as doing an Estate Plan in the first place. I often see Estate Plans in which children went unnamed, simply because they were not born, people who have payed far more in taxes than necessary, and assets that are forced to pass through probate, simply because the decedent forgot to place them in their trust.