Do You (Really) Need a "Bypass"?
Davis O'Sullivan & Priest LLC
129 Church Street, Suite 503
New Haven, CT 06510
Phone: 203-776-4400 / Fax 203-774-1060
(last updated 3/24/16)
| An estate plan for a couple
sometimes includes trusts designed to minimize taxes, by "sheltering"
assets from estate tax payable when the second person dies. The
plan is that assets of the first spouse to die "bypass" the second
spouse and instead, go into a trust. If you're a
Connecticut couple with more than $2 million and don't have these
trusts in your plan, you may need a bypass!
Why? Although NO federal or (in
almost all states) state estate tax is due when a person dies leaving
assets to a U.S. citizen opposite-sex spouse (in CT: or same-sex
spouse), the assets are then exposed to tax at the time of the
surviving spouse's later death. How much tax? Amounts in
excess of the federal exemption are now taxed at 35% and amounts in
excess of CT's state exemption taxed at 7.2-15%. In 2016, the
federal exemption is $5.45 million or -- if steps are taken when one
spouse dies -- $10.9 million. In CT, the exemption is only $2
million, and other states' exemptions are lower.
If a Connecticut couple's COMBINED assets are
under $2 million, no tax will be due when either dies, period. (Don't
get me started on the probate fee, up to
The tax is paid out of the estate or if there is no "estate" (no
probate), by the people who get the money: your family. NO tax is due
on amounts you leave to charity! But suppose the couple's
combined assets exceed these limits. Leaving aside federal estate tax,
there is still exposure to CONNECTICUT estate tax for a couple with
combined assets that exceed $2 million, because assets that pass to
your surviving spouse will be taxed as part of that spouse's estate on
that spouse's death.
Example: Ozzie has $2
million. Harriet has $2 million of her own. Ozzie dies
leaving his $2 million to Harriet. Harriet, grief-stricken, dies
a year later. She has $4 million -- her $2 M plus what she got
from Ozzie. On her death, the $4 million generates $146,400 in
Connecticut estate tax. You can click here for a PDF table with the rates, or try my spreadsheet. (CAUTION: CURRENT
TO 4/22/12 only.) Before the Bush tax cuts, there would be a
substantial hit of federal estate tax, too -- even on amounts over
$600,000. Who knows what 2013 will bring at the federal level,
but in Connecticut, Harriet can look forward to paying $146,400 for
One way to show this is a kind of math equation:
OZZIE $2M + HARRIET
$2M = HARRIET $4M
HARRIET $4M = FAMILY $3,853,600 + TAX $146,400
This problem could have been solved if
Ozzie's estate plan (will and/or trust) included a "bypass trust" AND
he had assets in his sole name or the name of his own separate trust,
that could be used to fund the bypass trust. His $2 million would have
gone into the trust for Harriet so that when she died, the Bypass Trust
would have owned $2 million and she, Harriet, would still have owned
only $2 million. Trusts aren't people and don't die, so no more tax on
the Bypass Trust assets. Harriet would have had $2 million only
-- no tax there either. So if Ozzie and Harriet paid their lawyer
$2,500 -$3,500 for this plan, they saved at least $143,000!
Pretty good deal!
So here is the solution:
$2M + HARRIET
$2M = BYPASS $2M + HARRIET $2M
BYPASS $2M + HARRIET $2M = FAMILY $4M
(1) As noted -- to "bypass" Harriet, Ozzie's assets have to get
into the Bypass Trust when Ozzie dies. If Ozzie's $2 million
consisted of his 401(k), this would have created complications.
There are very tricky rules about naming trusts and one false move can
result in the whole 401(k) paying out over a short period of
time. Since traditional IRAs, 401ks, 403bs etc. are "pre-tax,"
estate tax can be pocket change compared with the INCOME TAX that is
due on every dollar that comes OUT of the IRA, 401k and so forth.
It's usually preferable to leave these assets to the surviving spouse,
(2) What if Ozzie and Harriet went to a lawyer who drew up a
beautiful set of wills and Bypass Trusts for them and gave them
instructions on keeping assets in separate names, but they
forgot? Instead, Ozzie and Harriet went home and put the lovely
little folder of documents into the desk drawer and then went about
their business. When Ozzie died, the lawyer found out that all
assets were titled in joint names. A little eleventh-hour
"disclaiming" might have fixed things, but unfortunately, Harriet had
moved all the joint accounts to an account in her own name, and didn't
talk to the lawyer until ten months had passed, so no "disclaiming"
could be done.
(3) What if Ozzie had a plan like this, and $2 million in his own name,
but Harriet had only $100,000? Ozzie's entire $2 million would
probably have gone into the Bypass Trust. Since Harriet probably
would spend $100,000 on expenses during her remaining lifetime, the
plan would be more complicated than necessary. Instead of saving
$143,000, this plan would cost Ozzie and Harriet the original lawyer
fee plus fees to administer the trust and more lawyer fees to undo the
(4) What am I talking about -- what complications? What is a trust
anyway? CLICK for my article about
what it means to be the beneficiary of a Bypass Trust rather than
inheriting your spouse's estate outright.
If you don't like
the Bypass Trust, you have four alternatives: (1) spend the extra money
during lifetime! (2) give it away each year in amounts that don't
exceed $14,000 per donor, per donee, or qualify for the "med/ed"
exclusion, so you don't die with more than $2 million; (3) don't worry
about the Connecticut estate tax -- what's $146,400 in tax when you are
leaving $4 million to your ungrateful kids; or (4) give the excess over
$2 million to charity. Actually there may be a few other tricks -
consult a qualified estate planning attorney!
it comes to
the Bypass Trust, there may be as many variations as there are
lawyers. Even the name comes in different flavors. Some
this type of estate plan an "A/B" plan, which means that the "A" part
bypasses the surviving spouse and the "B" goes to a different kind of
trust for the surviving spouse, and/or passes outright. Some call
"credit shelter" plan. In some plans, the "marital" share
(non-bypassing) goes outright to the spouse and everything else is held
in trust. In community property states, there may be a
trust and a "Survivor's" Trust. The "Decedent's" community
half will bypass the survivor. So: if you see any of these
can feel pretty sure it is a "bypass" plan and the resulting trust is a
trusts do NOT help avoid paying for long-term care expenses and
qualifying for Medicaid. I assume that if you have more than $2
million, you can afford to pay some of this for long-term care and/or
purchase long-term care insurance -- but you should know that if your
surviving spouse is the beneficiary of a Bypass Trust, the Connecticut
Social Services will treat the trust as fully available to meet your
spouse's long-term care expenses - -the whole amount will in most cases
have to be
consumed before the beneficiary can qualify for Title 19.
EVERYTHING I JUST WROTE HAS EXCEPTIONS AND FINE POINTS
AND MAY CHANGE AT THE WHIM OF CONGRESS, THE STATE LEGISLATURE,
ETC. THIS IS A VERY GENERALIZED EXPLANATION. IT IS ABSOLUTELY
ESSENTIAL THAT YOU MEET WITH YOUR OWN ATTORNEY AND PROVIDE YOUR
ATTORNEY WITH FULL INFORMATION ABOUT WHAT YOU OWN AND THE WAY IT IS
TITLED -- AND THAT YOU FOLLOW YOUR ATTORNEY'S INSTRUCTIONS!