For the past nine years, the federal estate tax rules have been changing and they shifted again on January 1, 2010. As of that date, the federal estate tax has been repealed, although it is scheduled to return in 2011 with a $1 million exemption and 55% rate. For this year, there is complicated alternate tax regime that allows executors to apply up to $1.3 million in basis to (with an additional $3 million for a surviving spouse) to assets of a decedent to avoid capital gains tax upon sale of the assets. Because of the the changes and uncertainty about possible retroactive imposition of the estate tax for this year, virtually everyone with assets in excess of $1 million should have their estate plan reviewed.
Bypass Trust Arrangements May Need Tweaking
One example of the need for an updated estate plan occurs when a married couple has set up a bypass trust arrangement in their wills or living trust documents. (Bypass trusts are also commonly called credit shelter trusts).
In addition to tax law changes, the following events may call for estate plan revisions:
The main purpose of a bypass trust is to allow both spouses to take advantage of their respective federal estate tax exemptions. Typically, assets with value equal to the current exemption amount are automatically put into the bypass trust when the first spouse dies. The trust is created at that time and is irrevocable.
The beneficiaries of the trust are designated by the first spouse to die, and the assets used to fund the trust come out of that person’s estate when death occurs. Typically, the trust beneficiaries are that person’s children and/or grandchildren.
Since the first spouse to die designates the beneficiaries of the bypass trust, the assets used to fund the trust are included in that person’s estate for federal estate tax purposes. However, no federal estate tax is due because that person’s estate tax exemption provides sufficient shelter.
The surviving spouse can be given money from the bypass trust to meet his or her reasonable financial needs. When the surviving spouse passes away, the remaining assets in the bypass trust go the beneficiaries of the trust (such as the children and/or grandchildren).
The Potential Problem
Most wills and trusts don’t state a specific value for the assets that will be used fund the bypass trust. Instead, the language effectively states that assets with value equal to the current federal estate tax exemption amount will be placed in the trust. But with no estate tax in effect, this arrangement will not work. Also, such provisions do not have the flexibility to take into account income tax issues as well. Alternate provisions are necessary to take advantage of current laws in the event the estate tax is not reinstated retroactively, and the possibility of a future estate tax exemption of anywhere from $1 million to $5 million.
The Bottom Line
Throughout your life, your estate plan will have to be altered at times due to tax changes and other events. Some situations are inherently unpredictable–like winning the lottery or losing a bundle in the stock market. However, it’s a fact that the federal estate tax laws are in flux and proper planning is needed. Therefore, don’t delay contacting consult your estate planning attorney about whether you need to take action.