Proper tax planning is vital if you are trying to protect valuable assets. A properly drafted estate plan can diminish, or even avoid, federal gift and estate taxes. A bypass trust and portability are the two strategies that are commonly used to avoid an estate tax bill following the death of one spouse. Deciding between the portability election and a bypass trust requires a better understanding of both options. Toward that end, the estate planning attorneys at Legacy Care Law Firm offer a comparison of the use of portability with a bypass trust.
Why Tax Planning Is Important
Whether or not your estate will incur a federal gift and estate tax debt depends primarily on the value of your estate at the time of death co and any qualifying lifetime gifts you made before your death. Fortunately, all taxpayers are entitled to make use of the “lifetime exemption.” The lifetime exemption also fluctuated prior to the passage of ATRA which set the exemption at $5 million to be adjusted annually for inflation; however, changes were made to the federal gift and estate tax by President Trump that temporarily raised the lifetime exemption amount through 2025. For 2023, the individual Lifetime Exemption amount is $12.92 million. In 2026, the lifetime exemption amount is scheduled to return to the previous amount of $5 million adjusted for inflation. Any assets that due incur federal estate taxes are taxed at a flat rate of 40 percent, meaning an estate could lose a significant amount of its value to estate taxes.
Options for Avoiding Estate Taxes When One Spouse Passes Away
There are two commonly used strategies for avoiding estate taxes on the estate of a deceased spouse. The first involves including a “bypass trust” provision in the Will or living trust created by both spouses. The second is to wait until the death of one spouse at which time the surviving spouse makes a “portability” election that effectively transfers the deceased spouse’s applicable lifetime exclusion to the surviving spouse.
What Is a Bypass Trust?
Also referred to as a “shelter trust,” a “family trust” or the “B” trust in an “A-B” trust, a bypass trust is created using a provision in a Will or a living trust. Either way, a bypass trust does not activate until the death of one spouse. At that time, the appropriate provision in the Will or living trust directs the Executor or Trustee to set aside, in an irrevocable trust, an amount equal to the deceased spouse’s applicable lifetime exclusion. This typically means a bypass trust is funded using the lesser of the available estate and gift tax exemption amount of the deceased spouse, or one-half of the deceased spouse’s community property, plus his or her separate property.
The surviving spouse is entitled to income from the bypass trust and may also have access to the principal, according to the terms of the trust. Distributions to other beneficiaries are also permitted. When the surviving spouse dies, any remaining principal can be distributed directly to named beneficiaries (such as the couple’s children) or can remain in trust for their benefit.
The benefit of a bypass trust is that the assets held in a bypass trust are not considered part of the survivor’s taxable estate. Assuming the bypass trust assets grow, that means the entire value of the bypass trust avoids estate taxes upon the death of the surviving spouse.
What Is the Portability Election?
Portability refers to a surviving spouse’s ability to use any unused portion of a deceased spouse’s lifetime exemption. If a deceased spouse did not use all his/her lifetime exemption, the unused portion can be “ported” over to the surviving spouse. For example, if your spouse passed away in 2023 leaving behind $10 million in assets, his/her estate would not owe gift and estate taxes because the value of the estate is less than the available $12.92 million exemption. The remaining $2.92 million can be “ported” over to the surviving spouse who can add it to his/her lifetime exemption. For 2023, that would mean a surviving spouse would increase his/her lifetime exemption to $15.84 million (his/her $12.92 million plus the remaining $2.92 million from the deceased spouse’s exemption = $15.84 million). The resulting lifetime exemption amount ($15.84 million in this example) can then be used by the estate of the surviving spouse to reduce any estate tax burden. To make use of portability, you must make a portability election shortly after the death of a spouse.
Contact Our Estate Planning Attorneys
For more information, please download our FREE estate planning worksheet. If you have additional questions or concerns about estate planning, contact our estate planning attorneys in our North Andover, Woburn, and Beverly offices at (978) 969-0331. Our Salem and Nashua, New Hampshire office can be reached at (603) 894-4141.
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