Do You Still Need a Bypass Trust?

The Tax Cuts and Jobs Act of 2017 was touted as one of the most significant changes to the tax code in over thirty years. There was a sharp reduction in the federal income tax rate for businesses, a near doubling of the standard deduction for individual taxpayers and several important changes that impact estate and gift tax planning efforts. While the media focused on the broader changes that affect almost every taxpayer, there were other changes essential changes that impact estate and gift tax planning strategies. Among these was the doubling of the federal estate tax exemption and the increase of the annual exclusion amount for gift taxes. While these changes generally favor taxpayers, there are some leveraging estate planning tools such as bypass trusts, which could end up paying more in the end. To help clients, prospects and others understand bypass trusts and why they may be outdated, Wilson Lewis has provided a summary of the key details below.

What is a Bypass Trust?

This is a popular estate tax planning mechanism designed to bypass estate tax laws by leaving money to the trust rather than a surviving spouse. These trusts also known as A/B trusts were helpful when the deceased spouse left everything to the surviving spouse. When this happens the two trusts are created – the bypass trust and the survivor trust (A & B). The assets in the bypass trust do not belong to the surviving spouse but they have the right to use the assets and retain income collected from the trust’s assets. The second trust, known as the survivor’s trust, is the property of the surviving spouse and they can do with it as they please. The tax savings comes upon the death of the second spouse when the assets of the bypass trust pass tax-free to the final beneficiary (often children).

What Changed?

The Tax Cuts and Jobs Act of 2017 doubled the federal exemption so that many couples don’t need to worry about federal estate taxes at all. An exemption of $22 million is portable between spouses and won’t expire until December 31, 2025. Since there is now a higher exemption and portability between spouses the bypass trust is essentially obsolete. Another concern is the potential for paying increased capital gains tax. Assets in bypass trusts do not receive a step-up in cost basis, which means that after the surviving spouse dies, heirs would pay a higher capital gains tax. For example, a taxpayer’s bypass trust contains $1 million in mutual funds that pass tax-free to the surviving spouse upon his/her death. The mutual funds’ value continues to grow and upon the surviving spouse’s death, the value has increased to $2.5 million. Final beneficiaries would now be responsible for paying taxes on the total gain of the mutual fund rather than on the stepped-up basis.

Limitations of Bypass Trusts

Aside from changes to estate tax exemptions and tax law, there are other inherent flaws in bypass trusts, including the issue that the surviving spouse does not fully control the trust’s assets. Although this was the means to an end to avoid paying estate taxes, it often creates more problems (depending on the couple) than solutions. It’s important to note that bypass trusts are an essential planning tool under certain circumstances, including when a(n):

• Estate is valued at more than $22 million
• Lifespan is expected to go beyond 2025 when the current federal exemption reverts back to 2017 amounts
• A desire to protect assets from creditors and/or probate
• The expectation that the surviving spouse could remarry
• Mixed family from multiple marriages

Contact Us

Tax reform had a significant impact on virtually every aspect of tax planning and compliance including estate and gift tax planning. The value of traditional tax planning devices such as bypass trusts has diminished under the new law. For this reason, it’s essential to consult with a qualified professional to review your estate plan and determine what is the best course of action is for your situation. If you have questions about bypass trusts or need assistance with estate planning, Wilson Lewis can help! For additional information please call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.