As a part of the resolution to the fiscal cliff, the American Taxpayer Relief Act of 2012 (ATRA) extended and made permanent a number of important tax code provisions that impact estate planning, including the now-$5.25 million estate tax exemption (after inflation indexing), and the portability of a deceased spouse’s unused exclusion amount (DSUEA) to carry over some or all of that $5.25 million to a surviving spouse. The end result of these changes: married couples can shelter as much as $10.5M of net worth from the estate tax system simply by doing nothing more than leaving everything to a surviving spouse with a simple Will and filing an estate tax return.
The ramifications of these changes will significantly impact estate planning for years to come, as the higher exemption drastically reduces how many people will be subject to the estate tax in the future, and portability in particular renders the use of bypass trusts largely irrelevant. In fact, bypass trusts actually become an adverse strategy for many, given both the direct cash costs of trust drafting and administration, and the indirect income tax consequences like compressed trust income tax brackets and the loss of any step-up in basis at death.
While bypass trusts will still remain relevant in some situations, from their usefulness to shelter future growth from taxation for very high net worth couples and to preserve the GST exemption (which is not portable), to their utility for state estate tax planning. In addition, use of trusts in general will remain relevant for many non-tax reasons, especially asset, divorce, and spendthrift protection. Nonetheless, the bottom line is that with the new rules, esecpially portability of the estate tax exemption, it may be time to bypass the bypass trust for the overwhelming majority of Americans!