Wills With Tax Planning
In the overwhelming majority of Texas estates on which the attorneys of Ford+Bergner provide advice, the Testators are primarily concerned about two issues: 1) dividing and distributing assets at death, and 2) reducing or eliminating taxes paid as a result of death.
Like the simple Wills, a Will with tax planning lays out the distribution of a Testator’s estate. However, unlike the simple Will, the Will, including tax planning provisions, is designed to reduce or eliminate estate tax consequences of individuals or married couples having larger estates.
The estate tax is a tax imposed by the federal government to transfer wealth from one person to another. The tax is based on the fair market value of all of the assets owned by someone on the date of their death. This generally includes homes, bank accounts, cars, stocks, bonds, life insurance, IRA’s, retirement accounts, etc.
However, every person in the United States enjoys a certain lifetime exemption from the estate tax. In 2010, Congress revamped the estate tax exemption so that it increases yearly for inflation. Thereafter, Congress made further changes to it so that the exemption increased in 2018 to approximately $11.2 million per person in America. The exemption will continue to increase each year until Congress reviews it in 2026.
In addition to the estate tax exemption, Congress allows married individuals to make gifts either during life or at death to their spouse without triggering any estate taxes. These gifts, instead, pass outright to the spouse and are later included in the spouse’s estate upon their death.
To aid in understanding some of the estate tax concepts and the related provisions included in a will with tax planning, the following is an illustration of a situation where tax planning may be necessary:
Husband and Wife are married with 2 children. At the time of Husband’s death in 2018, he and Wife have a combined estate of $16 million, half of which is considered to be Husband’s. Husband’s will leaves everything outright to his Wife. Wife later dies in 2019 and leaves everything to the children equally.
When the Husband died in 2018, the Wife will not be required to pay estate taxes because the Husband left everything to Wife, and gifts to a spouse are not subject to estate taxes. In 2019, when Wife dies, however, her estate consists of the entire $16 million that she and Husband owned jointly. Because Wife receives an exemption of $11.5 million in 2019, the remaining $4.5 million in assets are going to be subject to estate taxes at Wife’s death. Historically, when the Wife died, she lost the Husband’s exemption because he had left everything outright to the Wife.
However, when Congress enacted its changes in 2010, it created the concept of portability, which is discussed in more detail below. Portability allows the Wife in the example above to use the Husband’s estate tax exemption at her death.
In 2010, Congress created the concept of portability for the first time. Before that action, anytime one spouse died and left assets outright to the surviving spouse, the first spouse’s estate tax exemption was lost and unable to be used at the death of the second spouse. That all changed in 2010.
Portability allows the estate tax exemption of the first spouse to be ported over and used at the second spouse’s death. In essence, it allows the couple to combine their exemptions and leave double the amount of assets to their children without paying estate taxes.
In the example above, the Husband died and left everything to the Wife. At Husband’s death, he had an exemption of $11.5 million. When Wife later died, she had an estate of $16 million and her own exemption of $11.5 million. Because of portability, the Wife could eliminate all of the estate tax at her death because her assets of $16 million were less than her available exemption of $23 million (her exemption + her husband’s exemption).
In a situation like the one presented in the Illustration above, most couples would like to 1) leave all of the assets for use by the surviving spouse and 2) capture both spouses’ estate tax exemptions so that the maximum assets will be excluded from tax.
As an alternative to using the portability concept, the Husband could create a testamentary trust, commonly referred to as a “Bypass Trust.” Created in a Will, the Bypass Trust is designed to reduce or eliminate estate taxes while still providing the use of all of the assets for the surviving spouse. Assuming that Husband dies first, as in the Illustration above, Husband’s Will would provide that an amount equal to his estate tax exemption amount would be placed into Trust for Wife’s benefit for her lifetime Husband would appoint Wife as the trustee of the Trust. It would further provide that upon Wife’s death, the remainder of the Trust would be divided equally between their children (or in any manner Husband deemed appropriate).
When the assets are placed into the Trust, Wife has the use of the assets for her lifetime, and as the trustee of the Trust, she has the ability to decide when it is appropriate for her to use the assets. However, whatever assets are left in the Trust at Wife’s death are passed to the children without paying any estate taxes.
Using the same facts as the last Illustration, but instead of leaving the assets outright to Wife, Husband includes a Bypass Trust in his will. What portion of the Estate is taxable at Wife’s death?
When the Husband died in 2018, his exemption amount of $11.2 million exceeds the value of his half of the estate, which is $8 million. The entire $8 million is placed into the Bypass Trust for Wife’s benefit. When Wife later died in 2019, her estate consists of the $8 million that she had before the Husband’s death (the monies held in the Trust are not counted as part of Wife’s estate).
Why Create the Bypass Trust?
Because portability now exists, there is no need to create a bypass trust any time a married couple’s estate is large. However, a bypass trust can often be useful in situations with blended families. In those cases, the Husband can leave his assets in a bypass trust with the Wife as the beneficiary during her lifetime. When the Wife later dies, Husband’s Will would control the distribution of the bypass trust assets. If the Husband had left all of the assets outright to Wife, Wife’s Will would control all assets. However, if the Husband leaves his assets in a bypass trust, he exempts the assets from estate taxes and ensures that he can control his assets’ ultimate disposition at Wife’s later death.