In the world of Trusts & Estates, there is a litany of Trust types all in variance according to the needs of either the Grantor (the Creator of the Trust) or the beneficiary (the person or entity who benefits from the Trust). Insurance Trusts, Special Needs Trusts, Spendthrift Trusts, & Trusts for Minors are only a few that seem to play a repetitious role in estate planning.
None however, are used more than the Bypass Trust. Also known as a Q-Tip Trust, the Bypass Trust is simple in nature, but provides long lasting benefits. The Bypass Trust deals with the issue of estate taxation; more specifically, the use of the estate tax exemption. As you know, The Federal estate tax exemption was increased to $3.5 million in 2009. This means that an estate valued at $3.5 million or less suffers no estate taxes. Any amount over $3.5 million is taxed at a rate of 45%! This exemption is scheduled to be unlimited in 2010 and then reduced back down to $1 million in 2011, but there is already talk in Washington regarding changes in both the schedule and a reduction of the exclusion amount due to the economy.
Up to and including 2008, Connecticut matched the Federal exemption amount. But when the federal exemption increased from $2 million to $3.5 million, Connecticut remained at $2 million, which complicates the bypass process and changes the Trust value on a state level. (Other states vary as well.)
A Bypass Trust uses the art of Trust language to work the exemption to its greatest potential. Here’s how it works. Normally, when a person dies, leaving a surviving spouse, everything in the dying spouse’s estate is allowed to pass to the surviving spouse tax free. Nice, Huh? Here’s the issue. When both spouses were alive, they each owned half of the estate. Now, the surviving spouse owns the entire estate, which is now double in size and has a greater chance of being exposed to taxation above the exemption allowance.
A bypass Trust, which can be either an Inter Vivos Trust (made and executed while living) or a Testamentary Trust (a trust created in the decedent’s Will). The language of the Trust says instead of passing all of my estate to my spouse, put an amount equal to or less than the prevailing exemption amount in Trust for my spouse.
Ok, everyone likes examples. Tony & Connie are married and have a $6.5 million estate. Each is currently entitled to a $3.5 million tax exemption. Tony passes away (I’ll never outlive her). Without the Trust Tony’s estate passes to Connie tax free. Great, no tax (for now). But now Connie has a $7 million estate. When she dies, she gets her $3.5 million tax exemption, but… you guessed it; she now has another $3 million over her exemption which is subject to Federal taxes at a rate of 45%. Basically, the federal government takes half. (And don’t forget the state taxes!)
Same scenario, except, Tony has a Bypass Trust set up. Now when he dies, $3.5 million of his estate goes into the Trust (for Connie’s benefit) and the excess goes to Connie. A few months later Connie dies (because she finally figured out that she can’t live without me.) Now, Connie’s estate is only valued at the $3 million rather than the $6.5 million. So her estate now passes tax free as well because she is entitled to use her own $3.5 million exemption. And the kids are even happier because they inherit more of the estate (either as residual Trust beneficiaries or estate beneficiaries) and give less to the government.
Do you need a bypass trust? I put one in most of my clients Wills. It’s good to have regardless of the size of your estate because the amount of the exemption changes annually. When the exemption amount sets back to $1 million in 2011, the Bypass Trust will apply to most couples.
One caveat with all of this. The government is looking into Bypass Trusts and the current exemptions on a regular basis. If you intend to prepare such documents, seek legal counsel. In estate planning, the laws change often and legal counsel is necessary to ensure that such trusts are prepared and worded properly.
Anthony J. Medico, Esq., has practiced law for over 15 years. To ask a question for this column, or to receive Medico’s free Estate Planning Survival Guide, visit his website at www.ajmedico.com, send an e-mail to Anthony@ajmedico.com or call (203) 661-8151.
The Law Offices of Anthony J. Medico
7 Benedict Place v Greenwich, Connecticut 06830
Telephone (203) 661-8151 v Facsimile (203) 625-9612
Anthony@ajmedico.com v www.ajmedico.com
