Repeal of Estate Tax Causes Problems with Bypass Trusts

NB: This article was published on April 19, 2010 and contains information that may be outdated. For current information regarding the estate tax, read: Estate Tax Certainty…For Now..

When EGTRRA was passed in 2001, it gradually increased the amount of assets that a decedent could pass without estate tax liability. In 2002, the exemption amount was $1 million, but by 2009, Americans could pass up to $3.5 million tax free.

To maximize the amount of assets that could be passed to their heirs free of estate taxes, many couples included bypass trusts in their estate planning documents.

The trust language provided that when one spouse died, an amount equal to the maximum federal exemption should be placed into the trust, with the balance of the estate passing to the surviving spouse either outright or in trust.

Because the exemption amount was frequently changing, linking the amount placed in the trust to the maximum that could be passed free of estate tax maximized the estate tax savings.

But in 2010, there is no estate tax. So if a person dies and his estate planning documents call for the bypass trust to be funded with the maximum amount that could be passed free of estate tax, the decedent’s entire estate would be placed in a bypass trust and nothing would be left to or for the sole benefit of the surviving spouse.

In cases where the spouse is a beneficiary of the bypass trust, the result may be acceptable. But in other cases, such as in second marriages where the trust beneficiaries are the decedent’s children from another marriage, the surviving spouse could be completely disinherited.

The confusion and ambiguities associated with the repeal of the estate tax has an end in sight. The estate tax will be reinstated on January 1, 2011 for estates worth more than $1 million, unless Congress passes new estate tax legislation earlier.