Tax and financial advice from the Silicon Valley expert.

Should a bypass trust be modified?

With recent changes in the Federal estate tax laws, including a current exemption amount of $5,430,000 and portability of the unused exemption of the most recently deceased spouse, many families have bypass trusts that aren’t tax efficient.

A big concern is the tax basis (cost for computing gain or loss for income tax reporting) is adjusted to the date of death value for inherited property. If property is in a bypass trust and not included in the taxable estate of the surviving spouse, the tax basis for that property won’t be adjusted at the death of the surviving spouse.

Some families have decided to simply terminate their bypass trusts. When you do this, the remainder beneficiaries of the bypass trust (usually the children or grandchildren of the couple) lose the assurance that they will receive their inheritance. The surviving spouse could remarry or otherwise leave the assets to someone else. In addition, assets held in a bypass trust usually enjoy creditor protection.

An alternative is to modify the bypass trust to include a general power of appointment in favor of the creditors of the surviving spouse. The property would then be included in the taxable estate of the surviving spouse. The inheritance of the remainder beneficiaries can be unchanged. If the surviving spouse has sufficient assets to pay his or her liabilities, there will actually be no effect on the ultimate distribution of the assets of the bypass trust.

The general power should only be exercisable at the death of the surviving spouse (usually by an exercise in the will or trust.)

The modification can only be made by agreement of the current beneficiaries, including remainder beneficiaries, of the trust with court approval. If the family members aren’t getting along, it probably won’t work. The family members should each have their own legal counsel.

What if Congress later changes the tax laws to reduce the federal estate tax exemption?

What if the property in the bypass trust dramatically increases in value?

What if some or all the property in the bypass trust decreases in value? (A formula can be created in the trust to deal with this issue.)

What if the surviving spouse receives an inheritance, wins the lottery, or otherwise acquires an estate exceeding the estate tax exemption?

What about the generation skipping tax?

This may not be as simple a decision as it first appears. It should only be made with good tax and legal counsel.

Tax and financial advice from the Silicon Valley expert.