A bypass trust is an irrevocable trust that was once commonly used by married couples to protect property from estate taxes in order to maximize what was passed on to the next generation. This is because if a spouse passes away, leaves everything to the surviving spouse, and the property exceeds the estate tax exemption, the surviving spouse’s estate will be responsible for paying estate taxes when he or she passes away. This can dramatically reduce the amount of inheritance that their children or other heirs receive.
How Bypass Trusts Work
A bypass trust involves spouses splitting the value of the combined estate and both spouses simultaneously executing irrevocable trusts. When the first spouse passes away, the surviving spouse will not have control over the deceased spouse’s trust, but will be provided payments from the trust for the remainder of his or her life. Because the surviving spouse does not have direct access or control over the principal in the trust, it is not a part of that spouse’s estate and is therefore not considered for estate tax purposes. When both spouses pass away, the estate then passes to the next generation without estate tax consequences. These trusts thereby act as legal tax shelters.
The Estate Tax Exemption Increased
In 2012, there was a dramatic increase in the estate tax exemption, which increased to $5 million per person and 10 million for a couple. As of 2017, the exemptions will be $5.49 million and $10.98 million, respectively. The results of this are two-fold. First, most families do not have $10.98 million in combined property, mooting the underlying purpose of bypass trusts as a tax shelter.
Second, the federal and state estate taxes can be up to 55% of property that exceeds the exemption, while long term capital gains taxes are 20%. These percentages are important. This is because trusts are subject to capital gains taxes, which heirs become responsible for when they inherit the property in the trust accounts.
In the past, married couples were essentially choosing for their heirs to pay capital gains instead of the estate paying the much larger estate tax. However, with the increased estate tax exemption, the property in trust no longer sees those estate tax benefits, while heirs are stuck with a significant capital gains tax.
Contact The Law Offices of Robert S. Thomas
Estate planning and taxation are incredibly complex. Further, changes in the law can create significant consequences that can undercut your intentions. If you have executed a bypass trust, but are interested in making changes, contact an attorney. I have been a taxation and estate-planning attorney for over two decades and can provide you with current, relevant legal advice that is tailored to your needs. Contact the Law Offices of Robert S. Thomas at 847-392-5893 for an initial consultation or visit our website today.