Is a Bypass Trust Necessary? – Annapolis and Towson Estate Planning

A bypass trust removes a designated portion of an IRA or 401(k) proceeds from the surviving spouse’s taxable estate, while also achieving several tax benefits, according to a recent article titled “New Purposes for ‘Bypass’ Trusts in Estate Planning” from Financial Advisor.

Portability became law in 2013, when Congress permanently passed the portability election for assets passing outright to the surviving spouse when the first spouse dies. This allows the survivor to benefit from the unused federal estate tax exemption of the deceased spouse, thereby claiming two estate tax exemptions. Why would a couple need a bypass trust in their estate plan?

  • The portability election does not remove appreciation in the value of the ported assets from the surviving spouse’s taxable estate. A bypass trust removes all appreciation.
  • The portability election does not apply if the surviving spouse remarries, and the new spouse predeceases the surviving spouse. Remarriage does not impact a bypass trust.
  • The portability election does not apply to federal generation skipping transfer taxes. The amount could be subject to a federal transfer tax in the heir’s estates, including any appreciation in value.
  • If the decedent had debts or liability issues, ported assets do not have the protection against claims and lawsuits offered by a bypass trust.
  • The first spouse to die loses the ability to determine where the ported assets go after the death of the surviving spouse. This is particularly important when there are children from multiple marriages and parents want to ensure their children receive an inheritance.

This strategy should be reviewed in light of the SECURE Act 10-year maximum payout rule, since the outright payment of IRA and 401(k) plan proceeds to a surviving spouse is entitled to spousal rollover treatment and generally a greater income tax deferral.

Bypass trusts are also subject to the highest federal income tax rate at levels of gross income of as low as $13,550, and they do not qualify for income tax basis step-up at the death of the surviving spouse.

However, the use of IRC Section 678 in creating the bypass trust can eliminate the high trust income tax rates and the minimum exemption, also under Section 678, so the trust is not taxed the way a surviving spouse would be. There is also the potential to include a conditional general testamentary power of appointment in the trust, which can sometimes result in income tax basis step-up for all or a portion of the appreciated assets in the trust upon the death of the surviving spouse.

Every estate planning situation is unique, and these decisions should only be made after consideration of the size of the IRA or 401(k) plan, the tax situation of the surviving spouse and the tax situation of the heirs. An experienced estate planning attorney is needed to review each situation to determine whether or not a bypass trust is the best option for the couple and the family.

Reference: Financial Advisor (Feb. 1, 2022) “New Purposes for ‘Bypass’ Trusts in Estate Planning”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Can You Get a Tax Deduction for Giving a Gift? – Annapolis and Towson Estate Planning

Despite multiple proposals and countless legislative revisions, changes to everything from realizations of gains at death, lower federal transfer tax exemptions, raised estate tax rates and eliminating benefits of irrevocable grantor trusts, to name a few, have failed to become reality. However, that does not mean the proposals have disappeared for good, according to the article “Five Situations When Taxable Gifts Make Sense” from Wealth Management. In this environment, estate planning still needs to be done, although the tools to do so may be slightly different in case the tax laws change—or if they don’t.

Here are five different situations where making taxable gifts over the current $16,000 gift tax annual exclusion makes sense.

If you want to make a gift. You may want to make a gift, so a child can buy a home or start a business venture. Perhaps you want to bring a child into the ownership of a family business, or you simply want to share your wealth, more than the $16,000 exclusion. The federal gift tax exemption has never been this high, and the only tax downside might be the need to file a gift tax return.

What about the Step Up in Basis? The main reason not to make taxable gifts now is the step-up in income tax basis. Under current rules, assets transferred at death receive a step-up in income tax basis to the value at the time of death. Assets transferred by gift do not receive this benefit. If you wanted to give a $2 million property with a $100,000 tax basis, you will need to be prepared for the tax consequences.

Do you own rapidly appreciating assets? The main reason to make taxable gifts concerns appreciation. If your estate is well over the estate tax exemption, your heirs will save 40 cents for every dollar of appreciation, better in the hands of heirs rather than part of your estate. In this case, giving early makes all the difference. Business owners may give stock based on the growth they hope to achieve for a company.

Do you have a very large estate with high-basis assets and haven’t used your exemption? By all means, be generous! Under the current rules, even with no legislative changes, everything will be cut in half in 2026.

Are you sure your tax liability is going to increase in the future? Then making gifts today will help in the future.

Gifting can be a good way to spread income among family members, while avoiding having assets subject to a wealth tax. Gifting may also work to establish structures, like irrevocable grantor trusts or family limited partnerships, which might be more complicated in the future.

It is hard to say what the transfer tax rules will be five, fifteen, or fifty-five years from now. However, there are situations where making significant gifts makes sense. Remember, while the only sure things in life are death and taxes, tax laws do change.

Reference: Wealth Management (Feb. 2, 2022) “Five Situations When Taxable Gifts Make Sense”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys