SUPPOSE YOU and your partner have substantial wealth, but you aren’t legally married. To ensure you both take advantage of the federal estate tax exclusion, you might use a bypass trust, which is funded upon your death under the terms of your will or living trust.
Let’s say you die first. Upon your death, your will might direct that a sum equal to the federal estate tax exclusion—$13.61 million in 2024—should go into a bypass trust, with the money perhaps earmarked for your favorite niece but with your partner still able to receive income from that money. This will use your estate tax exclusion. Upon your partner’s death, another $13.61 million (though likely more, thanks to inflation adjustments) would pass free of federal estate taxes, for a total of some $27 million.
Thanks to the portability of the federal estate tax exclusion, wealthy married couples have less need to use bypass trusts, also known as AB trusts. Many couples—who built bypass trusts into their estate plan when the estate tax exclusion was far lower—should probably revisit their plan, and will likely need to revise their wills and living trusts.
Still, bypass trusts could make sense for some married couples. By stashing assets in a bypass trust upon the death of the first spouse, you sidestep the risk that those assets might appreciate substantially in the years between the first spouse’s death and the second. If that happens and the bypass trust is not used, federal estate taxes may be an issue upon the death of the second spouse, even though the second spouse’s estate gets to make use of both spouses’ estate tax exclusions, thanks to portability.
On the other hand, if the assets are held in a trust and they increase substantially in value, your beneficiaries may have a different problem: capital gains taxes. That problem would be avoided if you simply leave the money to your spouse, because the assets would have their cost basis stepped up to the current market value upon your spouse’s death. Your estate planning attorney can help you figure out whether capital gains taxes or estate taxes are the bigger issue.
The answer will hinge partly on the size of your estate and how assets are invested. A bypass trust could also help with state estate taxes, where portability may not be allowed. In addition, a bypass trust might make sense if you’re remarried and have children from an earlier marriage. Even if the trust doesn’t deliver big tax savings, it could ensure that your wishes are followed. The trust might provide income to your new spouse after your death, while ensuring that your children ultimately inherit the assets involved. Often, this is also the motivation behind setting up a QTIP trust.
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