A recent blog post on our firm's McKonomics Website was very interesting and I thought it may be of value to my readers as it relates to some tax planning. Generally speaking, the fact that we currently have no federal estate tax is a good thing. However, the unprecedented temporary repeal may cause problems for some estates.
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Most advisors assumed the Senate would extend the 2009 estate tax exemption and rate structure through 2010. Little did we know, the healthcare reform battle would be at the forefront of our legislator's minds and the looming estate tax repeal would go unchanged. Here we are, roughly a month into 2010 and no word on if and how Congress will fix this mess. Will new legislation be passed during 2010? Will it be retroactive? How do we deal with basis step-up? We will save those debates for another time. For now, we want to focus on a simple, yet BIG issue that the current repeal may cause for many estates.
A bypass trust (or credit shelter trust) is a common estate planning tool used to preserve each spouse's lifetime exemption. Here is a simple example of how it works:
John and Mary are married and have a total net worth of $7,000,000. Assume all property is owned jointly. Also, assume that the lifetime exemption amount is $3,500,000 when both John and Mary pass away.
John passes away, leaving all of his assets to his wife. She now has a net worth of $7,000,000. Now when Mary passes away, she has a taxable estate of $3,500,000 ($7,000,000 total assets – her exemption of $3,500,000).
With a bypass trust, John would leave his half of their net worth ($3,500,000) in a trust when he passes, rather than directly to his wife Mary. Since Mary is not the ultimate beneficiary of the trust, the assets are not included in her estate when she dies. However, certain trust provisions allow her to have access to income from the trust assets if it is needed during her lifetime. By doing this, John utilizes his lifetime exemption of $3,500,000 when he passes his wealth to the trust, and Mary is only left with $3,500,000 when she passes away and does not have a taxable estate.
In order to accomplish this planning technique, many estate planners wrote wills with such language that the bypass trust would be funded with an amount equal to "the current lifetime exemption amount." Since we currently have no estate tax, and no lifetime exemption amount, if a spouse dies in 2010, we could potentially have an unfunded bypass trust. This is especially alarming since we can all assume the estate tax will come back and we may have a taxable estate once the second of the two spouses pass away.
Take the time to ensure that the repeal of the estate tax doesn't cause these problems for you and your family. It may make sense to adjust some of the language in your will. Please contact us and we would be happy to review your documents with you.