The 2010 Tax Act created a $5 million federal estate tax exemption. So why bother with a credit shelter or bypass trust in your will?
Give us a quickie explanation of a bypass trust.
It's a trust commonly used in estate planning by a married couple. Instead of leaving everything outright to the surviving spouse, you put some amount of assets in a trust. The trust gives the surviving spouse reasonable access to the money, but prevents it from being taxed in his or her estate.
So, now that we have a $5 million per person exclusion, and the surviving spouse can use any exclusion that his/her prior deceased husband/wife did not use, few people need bypass trusts anymore. Right?
It is never simple or easy with the tax law. The bypass trust is still necessary to save state estate tax. So, in high estate tax states like NY or NJ, these should remain common. Trusts have always provided a range of asset protection, remarriage protection, and other benefits.
Okay, so if bypass trusts still make sense, what will be different with the new law?
Older couples would sometimes set up a bypass trust on the first death up to the largest amount that could be protected from federal estate tax, even though they might pay hundreds of thousands of dollars in state estate tax for the privilege. This won't make sense for most people since under the federal estate tax law they won't pay federal estate tax on the second death because of the high exclusion and portability.
Anything else different?
Yes. We still have no clue what the law will be in 2013. All the new estate tax breaks only last 2 years. So taxpayers need to be flexible. Here's a new concept: the federal estate tax may be repealed in 2013, or if it is not repealed, almost no one will be wealthy enough to pay it. The IRS estimates less than 6,000 estates a year will pay tax. But capital gains might be much more costly to raise revenue. So, consider including in your bypass trust the right for an independent fiduciary, not a bank, to distribute the money outright to the surviving spouse. It may prove, in the future, a better tax deal to get a basis step up on death, to avoid capital gains costs the heirs would face than to keep the assets in the trust when no federal estate tax savings will occur.
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