Tax planning should always be part of a comprehensive estate plan. For anyone with high-value assets, tax planning is even more important. Proper tax planning can diminish, if not completely avoid, federal gift and estate taxes. Two common strategies used to avoid an estate tax bill following the death of one spouse are using a bypass trust and relying on portability. The Coral Gables estate planning attorneys at Stivers Law explain how a bypass trust works and how it stands up when compared to relying on portability.
Options for Avoiding Estate Taxes When One Spouse Passes Away
There are two commonly used strategies for avoiding estate taxes on the estate of a deceased spouse. The first involves including a “bypass trust” provision in the Will or living trust created by both spouses. The second is to wait until the death of one spouse at which time the surviving spouse makes a “portability” election that effectively transfers the deceased spouse’s applicable lifetime exclusion to the surviving spouse.
What Is a Bypass Trust?
Also referred to as a “shelter trust,” a “family trust” or the “B” trust in an “A-B” trust, a bypass trust is created using a provision in a Will or a living trust. Either way, a bypass trust does not activate until the death of one spouse. At that time, the appropriate provision in the Will or living trust directs the Executor or Trustee to set aside, in an irrevocable trust, an amount equal to the deceased spouse’s applicable lifetime exclusion. This typically means a bypass trust is funded using the lesser of the available estate and gift tax exemption amount of the deceased spouse, or one-half of the deceased spouse’s community property, plus his or her separate property.
The surviving spouse is entitled to income from the bypass trust and may also have access to principal, according to the terms of the trust. Distributions to other beneficiaries are also permitted. When the surviving spouse dies, any remaining principal can be distributed directly to named beneficiaries (such as the couple’s children) or can remain in trust for their benefit.
The benefit to a bypass trust is that the assets held in a bypass trust are not considered part of the survivor’s taxable estate. Assuming the bypass trust assets grow, that means the entire value of the bypass trust avoids estate taxes upon the death of the surviving spouse.
What Is the Portability Election?
Portability refers to a surviving spouse’s ability to use any unused portion of a deceased spouse’s lifetime exemption. If a deceased spouse did not use all his/her lifetime exemption, the unused portion can be “ported” over to the surviving spouse. For example, if your spouse passed away in 2022 leaving behind $10 million in assets, his/her estate would not owe gift and estate taxes because the value of the estate is less than the available $12.06 million exemption. The remaining $2.06 million can be “ported” over to the surviving spouse who can add it to his/her lifetime exemption. For 2022, that would mean a surviving spouse would increase his/her lifetime exemption to $14.12 million (his/her $12.06 million plus the remaining $2.06 million from the deceased spouse’s exemption = $14.12 million). The resulting lifetime exemption amount ($14.12 million in this example) can then be used by the estate of the surviving spouse to reduce any estate tax burden. To make use of portability, you must make a portability election shortly after the death of a spouse.
Contact Coral Gables Estate Planning Attorneys
For more information, please join us for an upcoming FREE webinar. If you have additional questions or concerns about creating a bypass trust to include in your estate plan, contact the experienced Coral Gables estate planning attorneys at Stivers Law by calling (305) 456-3255 to schedule an appointment.