Today’s estate tax situation:
Today, the situation is quite different.
- First of all, the estate tax exemption is now $5,000,000, in 2010 dollars. It’s already (2014) been inflation-adjusted to $5,340,000, and will, of course, continue to rise. A married couple has a total estate tax exemption today of $10,680,000. This has basically eliminated the estate tax for all but a handful of Americans: it’s estimated that less than 0.3% of estates will ever have to pay estate tax.
- Second, the maximum estate tax rate is now 40%, while capital gains rates are up to 20% — therefore, it’s not so clear that escaping estate tax is better than escaping income tax.
- Finally, we now have what is termed “portability.” The means that the surviving spouse can use the part of the first-to-die’s exemption that wasn’t used at his death.
These three factors have changed the estate planning picture drastically, causing some experts to say the Bypass Trust is obsolete. Let’s analyze that argument.
The $5 million exemption:
It goes like this: 99.7% of all couple’s estates will never exceed $10,680,000 in value (plus whatever additional inflation adjustment is tacked on) and thus their total estate will never be subject to estate tax. Therefore, we don’t have to worry about the first-to-die’s share of the estate escaping estate taxation.
So, we eliminate the Bypass Trust and give everything to the surviving spouse, or, if we’re worried that she’ll take everything and go to Las Vegas, or fall into the clutches of a mustachioed Lothario who will steal all the family money, we still put the first-to-die’s share into a Marital Trust.
Both the husband’s and the wife’s shares of the estate are taxable on the surviving spouse’s death, and both receive a step-up in basis. If the total estate is less than $10,680,000 (plus inflation) at the second spouse’s death, there’s no estate tax — but the step-up in basis still applies!
Let’s see how this works:
A married couple has a combined estate of $10,000,000, consisting of all community property. The husband dies in 2014.
Here’s how the trusts would be funded:
Survivor’s Trust: $5,000,000 (the wife’s half of community property)
Marital Trust $5,000,000 (the husband’s half of community property)
At the first death, again there would be no estate tax, as the husband’s half of the estate held in the Martial Trust qualifies for the marital deduction.
Portability means that any unused exemption in the first spouse’s estate can be carried to the second-to-die’s estate. So, if the first-to-dies’s portion of the estate is less than the exemption amount, the surviving spouse gets to use it.
At the second death, again the surviving spouse’s estate would be taxed on the amount remaining in the Survivor’s Trust and the Marital Trust. Because the first spouse to die left everything to the survivor, he didn’t use any of his exemption; the entire $5,340,000 exemption carries over to the estate of the surviving spouse.
Assuming the surviving spouse lives eight years, and the exemption continues to increase at the same rate it has been increasing, if the value of the total estate at the second death is less than $11,020,000 ($5,680,000 exemption for the wife and $5,340,000 for the husband) the estate will be exempt from estate tax.
But the assets from the total estate will still receive a full step-up in basis! The value of the estate assets will be equal to their stepped-up basis, so the heirs will be saved the 20% capital gains tax when they sell the estate assets.
On the other hand, any excess in value over that $11,020,000 will be subject to estate taxes at 40%.
What to do?
As noted, the vast majority of estates (99.7%!) will never have to worry about either or both spouses exceeding the exemption. In those cases, the estate of the first spouse to die can go directly to the surviving spouse or to a Martial Trust.
Similarly, in the case of very high net worth families, it will be clear that the family estate will exceed the combined exemption amount, and therefore a Bypass Trust should definitely be used.
These families will also continue to need advanced estate planning techniques such as life insurance trusts, grantor retained annuity trusts, charitable remainder trusts, and so forth.
In most cases, the couple developing their estate plan will have a very good idea of which category the estate falls into. But what should be done when the answer isn’t clear?
One suggestion is to delay the decision as to whether to rely on portability or go with the Bypass Trust as long as possible. This can be done by giving the surviving spouse the right to “disclaim,” that is, refuse to accept property from the first spouse to die.
As discussed above, the couples’ estate plan would provide the estate would be divided into two shares, the Survivor’s Trust and the Marital Trust, but the surviving spouse would have the right to disclaim any or all of the Marital Trust. Any disclaimed portion would go automatically into a Bypass Trust.
The surviving spouse would have nine months after the death of the first spouse to die to make her disclaimer, which hopefully would give her and her advisors a better feel for possible future appreciation in the assets.
The great thing about this technique is that the Bypass Trust, like those of old, can continue to provide the surviving spouse all the rights she had under the A-B-C Trust scenario.
That is, the surviving spouse may receive all the income, have the right to invade the principal of the trust for her benefit, and the right to name almost anyone as a beneficiary.
The disclaimer technique has a number of strict requirements (traps for the unwary!) and should only be planned for and utilized under the guidance of an estate planning specialist.
There are a number of other techniques that may be applicable to this situation. We shall have to wait to see what the estate planning community (and the courts) have to say about them.
The lesson to be drawn from all this is that you should review your estate plan and consult with your estate planning professional now and at regular intervals in the future.
— Published April 2014
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