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Estate Planning

Jan 02, 2017 11:31AM ● By Elena Hutslar

By Jeffrey Hall, MBA, CPA, Esq.

A once-popular estate planning tool may now cost families more in taxes than it saves. Changes in the estate tax have made the "bypass trust" a less appealing option for many families.  If your estate plan includes one, you should reconsider its necessity because it could be doing more harm than good.

When the first spouse dies and leaves everything to the surviving spouse, the surviving spouse may have an estate that exceeds the federal estate tax exemption. A bypass trust (also called an "A/B trust" or a "credit shelter trust") was designed to prevent the estate of the surviving spouse from having to pay estate tax. The standard in estate tax planning was to split an estate that was over the prevailing federal exemption amount between spouses, and for each spouse to execute a trust to “shelter” the first exemption amount in the estate of the first spouse to pass away. 

In 2013, estate taxes changed dramatically and now very few people are subject to federal estate taxes. Currently, the first $5.45 million (in 2016) of an estate is exempt from federal estate taxes, so, theoretically, a husband and wife would have no estate tax if their estate was less than $10.90 million. The estate tax is now also "portable" between spouses, accomplishing the same purpose as a bypass trust. This means that 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 the excess.

One problem with a bypass trust is that the surviving spouse does not have complete control over all the assets in the trust. The surviving spouse's right to use assets in the trust is limited and requires the filing of accountings and separate tax forms.

Another problem is that a bypass trust can actually 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. When an asset is in a bypass trust, it does not receive a step-up in basis because it is passing outside of the spouse's estate. If the assets are sold after the surviving spouse dies, the spouse's heirs will likely have to pay higher capital gains taxes than if the heirs had inherited the asset outright.

To find out if your estate plan contains an unnecessary bypass trust or, perhaps, if you need one, consult with Jeffrey Hall, Esq. Call today to schedule a free 30-minute consultation with the Law Offices of Jeffrey Hall, Inc. at (925) 230-9002 or go to Offices in Pleasant Hill and Benicia.