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Portability: Bypass Trusts and Estate Planning

Portability: Bypass Trusts and Estate Planning

By: Martin M. Shenkman, CPA, MBA, JD

Introduction/Overview: Everyone likes it simple. No one likes a complicated will. Now, with a $5 million exclusion and "portability" why bother with all that estate planning gobblygook?

√ Question: Let's first get some definitions down, so regular people (not lawyers) can understand what is going on with estate planning. What is a "bypass" trust? What is "portability"?

√ Answer: A "bypass" trust, as the name implies, is a trust to which assets are transferred on the first spouse's death. These assets and the income they generate are made available to the surviving spouse, but they "bypass" the surviving spouse's estate free of estate tax.

"Portability" is a new concept the 2010 Tax Act created. In really simple terms (and it's, in reality, about as simple as quantum physics), if your spouse dies, you may be permitted to use his or her unused estate exemption. That could effectively give you $5 million from your spouse and $5 million from your exemption so you can pass $10 million estate tax free with, in theory, no planning.

√ Question: Great, so who needs lawyers? We can do our wills for $100 bucks on line and we'll get a cooking show in this time slot.

√ Answer: Gary, hold the crepe recipes, its not so simple. Here's a few reasons:

  • These huge estate tax breaks are only good until 2013, then the law is up for grabs again. If Congress does nothing (could you imagine that?) the exclusion plummets to $1 million.
  • 50% of first marriages end in divorce and 60+% of second marriages. Do you really want to leave everything outright to your surviving spouse without a trust?
  • State estate taxes take a big bite of an estate and given state fiscal issues it doesn't seem likely that they will cut those taxes anytime soon.
  • Trusts are a great asset protection tool. Most people really need that protection.

√ Question: But doesn't this concept of portability solve many problems?

√ Answer: It might, but there are so many complications, limitations, and issues, that no one should really plan on using portability as their estate plan. It just won't work in too many situations. Instead, use the same bypass trust planning that folks have used for many years. Portability should only be used as a last resort after the fact in most cases. Consider:

  • Portability won't minimize state estate taxes.
  • Portability won't help with GST or generation skipping transfer taxes.
  • If the first spouse to die's executor doesn't file an estate tax return the entire benefit will be lost.

√ Question: So what is a good recommendation?

√ Answer: Everyone's situation is different so they really need to speak to their lawyer, but here are a few thoughts:

  • Include a bypass trust in your will to at least protect whatever the state estate tax exemption is (currently $1 million in New York and $675,000 in New Jersey).
  • Have the excess of the federal amount over the state amount ($5 million minus $1 million or $675,000) distributed to a marital trust that the executor can choose with hindsight how to treat (i.e., as a bypass or marital).
  • Everything over that can go to a marital trust.

Again, everyone's situation is unique and their goals and financial condition must be discussed to come up with a plan for them.

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