The Federal Estate Tax exemption for 2015 is $5.34 million per person. This is projected to rise to $5.43 in 2016. In addition, certain states also have estate taxes and the exemptions may be different than the Federal exemption. For example, Oregon has an Estate Tax with an exemption of $1,000,000 and a tax rate starting at 10% and going up to 16%. Federal estate taxes can go up to 40% of the estate.

One common type of trust used to manage the tax impacts for large estates is called the ‘Bypass Trust’. In this article I will describe the basic structure of the trust and how it could be used to minimize taxes for a married couple who wishes to leave their wealth to their children.

Typical Scenario

A typical estate planning scenario involves a couple deciding they would like to leave their estate to the surviving spouse and then have the assets pass to their children if the second spouse dies. This may be accomplished using wills. For the purposes of this discussion, let’s assume the couple has a combined estate net worth of $6M.

Tax Implications

In the first scenario, one spouse would pass their property to their spouse upon death. There is no tax in this case as there is an unlimited marital deduction. When the second spouse dies and leaves the property to the children, the estate tax will kick in. Is there a way to minimize the tax impacts?

Bypass Trust Explained

Let’s suppose instead that the couple sets up a trust that is funded when the first spouse dies. When the first spouse dies, $3M could go into the trust (a figure that is below the exemption limit of $5.34M). The trust would be used for the benefit of the surviving spouse during his/her lifetime and upon death the assets would go to the couples’ children.

When the second spouse passes away, the trust would be paid out to the children. In addition, the property of the second spouse would pass to the children. Each amount is below the $5.34M exemption, therefore there would be no estate taxes owed. In this case, the couple can take advantage of the fact that the estate tax exclusion is set per person.

If you are interested in learning more about whether a bypass trust could be used in your personal situation please contact Brightwood Ventures or you could talk with your estate tax attorney and/or tax accountant.