‘Portability’ is another option for spouses to avoid estate taxes
The information in this column is intended to provide a general understanding of the law, not as legal advice. Readers with legal problems should consult attorneys for advice on their particular circumstances.
Q: Would you please provide an update on the subject of bypass trusts? Our estate is a little over $10 million.
A: Under current law, each person has a $5.45 million exemption from federal estate and gift taxes. This amount is indexed for inflation and will increase a little at the start of each year. To the extent a person’s estate exceeds that amount, the excess is taxed at 40 percent.
If you make gifts while you are alive, the first $14,000 you give to any person each year is excluded from the gift tax, and gifted amounts in excess of this amount use up your lifetime gift tax exemption which is also equal to $5.45 million per person. To the extent you use up your lifetime exemption from the gift tax, you also use up your lifetime exemption from the estate tax.
Transfers during lifetime in excess of $5.45 million are taxed at the same 40 percent rate that applies to the estate tax. This gift tax exemption is also indexed for inflation and will be increasing along with the estate tax exemption in future years.
Married couples get two $5.45 million exemptions, one for each spouse, but to take advantage of the full $10.9 million that’s available, certain steps must be taken. The traditional approach has been to create a bypass trust, as you mentioned, where the spouse who dies first leaves up to $5.45 million in trust for the other spouse. Such a trust is available to the surviving spouse, but is not hit with estate taxes when the survivor dies.
Creating a bypass trust still works fine.
However, there is a new approach called “portability.” Until 2010, if a spouse with a taxable estate died without proper estate planning, and left his or her estate outright to the surviving spouse, the deceased spouse’s ability to shelter property from estate taxes after both spouses die was typically lost.
Even though the gift to the surviving spouse would not have generated any estate taxes due to the “unlimited marital deduction,” it meant the surviving spouse was left with all the property, but only one person’s exemption from estate taxes. The exemption of the first to die would have been lost if no bypass trust was created.
Now it’s not always necessary to create a bypass trust because when the first spouse to die leaves property directly to the survivor, the unused estate exemption can be added to the survivor’s exemption, potentially doubling the amount the survivor can give away free of gift taxes during a lifetime and estate taxes at death.
A bypass trust may still be a better option for many married couples because a trust is creditor-protected and can appreciate in value over time, whereas the unused exemption carried over is a fixed amount. Portability is not great for second marriages either.
Rather than mandating creation of a bypass trust in the will, a newly favored approach is to make the bypass trust optional through the use of disclaimers. Nothing is set in stone until after the survivor dies, and the survivor can choose between a bypass trust and portability.