On December 17, 2010, President Obama signed a bill that significantly overhauled the Federal transfer taxes: estate, gift, and generation skipping. Since then I have been explaining the provisions to other professionals, clients, potential clients, and basically anyone who will listen. Some of my clients needed advice so they could make decisions before the end of December. Others are just trying to grasp the significance of the changes in their own planning.
For married couples the foundation of their estate tax planning has been the by-pass trust. It goes by many names and there at least a half-dozen ways to fund it. In my presentations I often refer to it simply as the tax trust. Its purpose is to preserve the estate tax exemption of the first spouse to die – essentially doubling the exemption for married couples.
However, the new estate tax law includes something called “portability”. Portability allows the surviving spouse to stack any unused exemption from their just deceased spouse on top of their own exemption – essentially doubling the exemption! Does this mean that the venerable by-pass trust will shortly be on tax planning scrap heap?
This is the subject of a recent article by Forbes contributor, Deborah L. Jacobs. The idea of abandoning the by-pass trust will be appealing to many. After all, if it wasn’t for the estate tax most couples would be perfectly happy to just leave everything outright to their spouse. However, there are a number of planning reasons why it still may be advisable to create a trust for the benefit of the surviving spouse.
Reasons Not to Ditch the Trust
- The “Portability” provisions may not be renewed. The estate tax provisions, including portability, are not permanent and are only for 2011 and 2012. They would need to be renewed for 2013 and beyond.
- The estate tax exemption could revert to $1 million in 2013. Remember that 2012 is an election year. There has been considerable squawking about the increase in the Federal estate tax exemption. There is no guarantee that the exemption will not revert back to $1 million.
- The State of Washington does not have portability. Portability is strictly a Federal creation. Without a By-Pass trust, married couples that leave everything to their spouse will only be able to use the state exemption of the last spouse to die. This would likely be the result in other states that have their own estate tax.
- Portability does not apply to the GST tax exemption. If you wish to make a gift to grandchildren directly or in trust at the second death, preserving the GST exemption of the first spouse to die is an important option that is not available using portability.
- The surviving spouse and children would lose the benefit of asset protection. Very often one of the planning benefits of a trust for the surviving spouse is that it provides some asset protection and management provisions that could be beneficial for the surviving spouse and ultimately the remainder beneficiaries.