Do You Need To Worry About Estate Taxes?

By Gus Bernard

Assuming one’s aim is to conserve as many assets as possible to pass on to one’s heirs, minimizing estate and/or inheritance taxes is of prime importance. Next to the Marital Deduction, the use of a Bypass Trust is the method most often used to minimize such taxes for married couples with taxable estates. The Bypass Trust is also known as a Credit Shelter Trust, an A-B Trust, a Non-Marital Trust and a Marital Shelter Trust. It is actually a set of provisions written into an individual’s Last Will and Testament or Revocable Living Trust.

The Marital Deduction allows the first spouse to die to leave as many assets to the surviving spouse as desired, free of estate tax. If the surviving spouse’s resulting estate is sufficiently large, this Internal Revenue Service (IRS) benefit is, in fact, only a deferral of estate taxes. Those assets that pass tax-free to the surviving spouse at the first spouse’s death become part of the surviving spouse’s estate and are subject to tax upon the surviving spouse’s subsequent and inevitable death.

The purpose of the Bypass Trust is to avoid estate tax on those assets, and their appreciated value, by making assets belonging to the first spouse to die available to the surviving spouse while at the same time keeping those assets out of the surviving spouse’s estate. Because the assets are not part of the surviving spouse’s estate, they are not subject to estate tax at the surviving spouse’s death. The assets effectively “bypass” the surviving spouse’s estate and pass free of tax to the couple’s heirs.

Under current IRS Code, only estates valued at over $675,000 are subject to estate tax. This “unified credit equivalent” or “credit-shelter exemption” increases to $1 million by the year 2006. An estate that includes real estate, life insurance and, especially today, employee benefits may be worth more than its owner realizes and can easily exceed the credit exemption; many small businesses have a market value that exceeds it.

Any couple with a combined estate worth more than $675,000 should consider protecting these assets from current estate tax rates ranging from 37% to 55% by establishing a Bypass Trust. A person funds the trust with enough of the individual’s assets to absorb the unified credit equivalent remaining to that individual at death. Using a Bypass Trust, a couple can protect up to $1,350,000 of combined assets from estate taxes. Without a Bypass Trust, the couple with a large enough estate could lose the benefit of the first spouse’s unified credit equivalent, possibly costing the combined estate well upwards of $200,000 in additional taxes.

Couples should work with a qualified legal professional to establish a Bypass Trust, as complex issues may be involved. For example, it may be necessary to change beneficiary designations on life insurance policies, employee benefit plans and other assets to ensure goals are achieved. In addition, if a couple titles too many assets jointly, planning flexibility is lost and funding of the trust becomes problematic.

Estate planning is one of those topics most people prefer to avoid, but it is never too late to start. If minimizing estate taxes is an issue for you, your Last Will and Testament or Revocable Living Trust should contain a Bypass Trust.

Gus M. Bernard, M.A., J.D., is managing member of Bernard & Associates, LC, a general practice law firm concentrating in trusts and estates and commercial law. He can be reached at 410-964-5787 or online at http://www.lawyers.com/gusbernard.