Estate Updates: Bypassing the Bypass Trust.

• Author: Sheridan, Eileen F.
• Position: Estateplanning

there was a time when $22 million was a lot of money. Now, for a married couple, it's considered a "small estate," which is what estate planning practitioners refer to when the taxable estate value is below the lifetime exclusion amount. If the couple had a "large estate" (more that $22.4 million in 2018,) then there would be estate tax due when the second spouse passes away.

Under the Tax Cuts and Jobs Act, it's especially important for CPAs to suggest an estate plan review so the client is not left with an outdated estate planning structure that creates more administrative burdens with less tax planning benefits. While solutions are available when planning opportunities are missed, they may come at a cost.

Typical A/B Trust

What happens if the first spouse dies, but estate planning documents haven't been updated to reflect the significant increase to the lifetime basic exclusion amount of $11.2 million per individual in 2018?

Previously, when exclusion amounts were much lower and portability did not exist, trusts for married couples with small estates were drafted to require creating a survivor's trust and a bypass trust at the first senior's death.

This drafting approach was appropriate when the objective was to exclude appreciating assets from the survivor's estate at his or her death. But, funding highly appreciating assets into a bypass trust can cause a lost opportunity for receiving a step-up in basis at the second death without the benefit of saving any estate tax. This is especially true when there's a lengthy time horizon between the first and second death.

However, the bypass trust still may be useful for blended families, creditor protection planning and other situations, so it should be evaluated accordingly.

Strategies for Avoiding a Bypass Trust

Spouse No. 1 has died and the trust is irrevocable! What can be done?

The following are some post-mortem planning solutions for the surviving spouse when a bypass trust is mandatory, but no longer offers estate tax planning benefits. In all solutions, the assumption is made that all beneficiaries are treated the same for both the survivor's trust and the bypass trust.

Option 1: Petition the Court

Under California Probate Code Sec. 15403, if all beneficiaries agree, a trustee or beneficiary of an irrevocable trust may compel modification or termination of the trust upon petition to the court. The challenge with this approach is identifying all the beneficiaries and, if there are...