The American Taxpayer Relief Act, passed by Congress in 2013, ended a decade of uncertainty over Federal estate tax law and ultimately eliminated estate tax concerns for 99% of American families. With a $5 million exemption level (indexed for inflation) and the ability to more easily use a spouse’s unused exemption, there is reason to rethink your estate plan. These changes have caused families to shift their focus from how to avoid paying estate taxes towards how to minimize capital gains taxes for combined estates below $10 million. It might also mean that the common approach of using a bypass trust is no longer the best option.

Prior to 2013, the federal estate tax exemption level fluctuated wildly, from $675,000 in 2001, to an unlimited exemption in 2010, then to $5 million in 2011. In 2013, Congress permanently set the estate tax exemption level at $5 million per individual and raised the top tax rate to 40%. The exemption level for 2015 is $5.43 million, or nearly $11 million per couple (due to the inflation adjustment).

In addition to increasing the exemption level, Congress made a key provision called the “portability clause” permanent. “Portability” is the ability to transfer any unused exclusion amount between spouses. In years past, a credit shelter trust, also known as a bypass trust, was commonly used to preserve the deceased spouse’s exemption. With the introduction of portability, the surviving spouse no longer needs to establish a bypass trust at the time of the first spouse’s death to take advantage of the exemption. A tax filing can be done instead.

A bypass trust still has benefits in certain circumstances. If assets are left directly to a surviving spouse, the surviving spouse can change the trust terms. However, a bypass trust becomes irrevocable at death and is a useful way to ensure the decedent’s wishes are carried out. This is particularly important in a second marriage, or where there is a concern that the surviving spouse may change the beneficiaries.

For those with relatively simple family situations, the benefits of foregoing a bypass trust are lower accounting fees, more flexibility and an additional step-up in basis. A step-up increases the owner’s cost basis from what was originally paid to full market value at the time of death and essentially erases any unrealized capital gains. Assets transferred to a bypass trust at the first spouse’s death receive a step-up in basis, but not again on the death of the surviving spouse. If assets are instead left to the surviving spouse using the portability clause, there is another step-up at the surviving spouse’s death. If the surviving spouse lives well beyond the first spouse’s death and his or her assets appreciate, the potential tax savings could be significant.

Estate plan documents should be reviewed at least every five years. Depending upon when a trust document was drafted and the provisions used, your beneficiaries could be at a disadvantage. We would be pleased to answer any questions you might have on this complex topic, and to work with your estate attorney to determine if your trust documents need updating.

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