The American Taxpayer Relief Act of 2012 (ATRA) became law in January 2013. It has completely changed the estate tax playing field.
Since 1996, when I became an estate planning attorney, the estate tax exclusion amount, (the amount you could die with before an estate tax), has ranged from $600,000 to $5,000,000. Under ATRA, the estate tax exclusion amount was raised to $5,000,000 indexed for inflation. In 2014, it is $5,340,000. In 2015, it was $5,430,000. And in 2016, it is $5,450,000.
Each person has an estate tax exclusion amount. Married couples can use two exclusion amounts, But to do so, their living trust must include bypass trust provisions, which, at the first death, allows the surviving spouse to distribute the deceased spouse’s share of the assets to the bypass trust. The bypass trust assets will not be included in the surviving spouse’s estate, but they will not receive a step up in basis when the surviving spouse dies. The tax basis of these assets will be the date of death value.
When the exclusion amount was $600,000, couples with estates worth more than that needed two exclusion amounts, so they used a bypass trust in their living trust. For example, if Bill and Jane had an estate worth $900,000, one $600,000 exclusion amount wouldn’t be enough. But if they used a bypass trust, they could use Bill’s exclusion and Jane’s exclusion and exclude up to $1,200,000 from estate taxes.
But now that the exclusion amount is $5,450,000, most couples don’t need two exclusion amounts to avoid estate taxes. Most couples’ estates are worth way less than $5,450,000, so using a bypass trust is no longer needed. In fact, using a bypass trust can do harm.
Assets in the bypass trust will not receive a step-up in basis when the surviving spouse dies. If the children have to sell the bypass trust assets, they will have to pay a capital gains tax on the difference between the sale price and what the assets were worth when the
first spouse died.
Before ATRA, paying a capital gains tax was a trade off couples were willing to make because it was better than paying the much higher estate tax. But if your estate value is less than $5,450,000, there is no need to make this trade off. Remove the bypass trust provisions from your living trust and and avoid the capital gains tax for your children. Instead of including bypass trust provisions in your living trust, you should consider including disclaimer or marital trust provisions to avoid the capital gain tax.