This is the 10th in a series of 23 tax tips thatAdvisorOne is publishing on each business day in March as part of our Tax Planning Special Report (see our Special Report calendar for a more complete list of topics to be covered and experts who will deliver their insights).
The tax tip today comes from Gavin Morrissey, director of advanced planning at Commonwealth Financial Network in San Diego. Morrissey consults with the independent broker-dealer's reps on issues involving insurance, tax, executive benefits, business, and estate and charitable planning. He also consults with advisors on concentrated stock and stock option planning and writes a tax planning blog for AdvisorOne.
The Tip: Using Bypass Trusts for State Estate Taxes
Morrissey (left) says the increased estate tax exemption to $5 million was not the only surprise in The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010; it also provided portability, meaning that a spouse can inherit a deceased’s $5 million exemption—if it’s unused—increasing his or her exemption to $10 million. “People in an estate below $10 million—the majority of the country—don’t need to do much planning to shelter $10 million assets from estate taxes.” Indeed, Morrissey’s advisor clients are asking whether bypass trusts are any longer necessary. Do their wealthy clients need one now?
A bypass trust is an estate planning tool used by married couples to pass down assets after death without subjecting them to the estate tax. In 2009, for example, when the estate tax exemption was $3.5 million, a deceased spouse’s exemption could be allocated to a bypass trust, and any growth would be tax free to the beneficiaries upon the second spouse’s death. Now with portability, Morrissey says, “all you have to do is file a return and say he or she takes the exemption.”
But the matter does not end there. “I can put together cases where a bypass trust is still necessary,” Morrissey says. One is control, which enables the decedent to ensure specific wishes are taken care of.
But perhaps more important are state tax laws. “People love to talk about this federal act, but they completely ignore the state,” Morrissey says. He urges advisors to find out whether their clients are subject to estate taxes at the state level. For states with estate taxes, he says, he is unaware of any that provides portability of the estate tax exemption to the surviving spouse. The bypass trust can take advantage of the state’s exemption amount.
He cites Massachusetts, where Commonwealth Financial Network is headquartered, as an example. Local tax law provides a $1 million exemption, but the top tax rate is 16%. “If you’re worth $2 million, you should probably take advantage of that exemption on the first spouse’s death.”