How To Reduce Estate Taxes With a Bypass Trust

That old joke — that only two things are certain in this life, death and taxes, isn’t so funny anymore. Due to the estate tax law, even death does not free you from the shackle of taxes as the federal government assesses an estate tax for the privilege of transferring assets to heirs. The most common way for married couples to reduce estate taxes is by using a BYPASS TRUST, so-called because assets placed in this trust transfer to heirs directly after the death of the surviving spouse, thus bypassing the estate tax liability.

Prior to the American Taxpayer Relief Act 2012 (ATRA), if your estate is valued over $5M with inflation adjustment you need estate planning to avoid or reduce taxes.

The ATRA extends the portability provision which allows a surviving spouse to claim a deceased spouse’s unused federal exclusion amount. This means for a married couple, with proper planning, they will be able to pass $10.5 million to their beneficiaries without a gift or estate tax. To receive this benefit the surviving spouse must make an election on a federal tax return Form 706 at the death of his or her spouse to claim their deceased spouse’s credit. This election gives the surviving spouse the ability to increase the amount he or she that can pass free of federal estate tax.

Also, the trust has to be written in a very specific way in order for Individual Retirement Accounts(IRA’s) or other qualified deferred compensation investments (i.e. 401K) can be used to fund a Bypass Trust. There may only be one beneficiary of the Bypass Trust, it must be irrevocable and valid under state law. Further, when the participant reaches the required beginning date (RBD), generally April 1st following the year the participant reaches age 70 1/2, minimum distributions from this IRA account must begin. When the participant dies, if the IRA monies are paid to a Bypass Trust, the minimum distributions must continue and cannot be changed by the surviving spouse. If the surviving spouse is named as beneficiary of an IRA however, he or she can elect his or her own minimum distribution when he or she reaches the required beginning date.