This is a question that has arisen in my practice numerous times this year since “Portability” became permanent when the American Taxpayer Relief Act (ATRA) was signed in January 2013. And I’m sorry, but–the answer is “Maybe”.
The Way It Was
The majority of my clients want the surviving spouse to continue to be able to use all of the couple’s assets after the first spouse dies. In the not so distant past, when the Estate Tax Exemption (Exemption) was $600,000 (increasing to $1 million over a period of years), and estate tax rates were up to 55%, this was a real problem. If clients with $2 million in assets provided for all assets to pass outright to the survivor, then when the survivor died owning the whole $2 million, there could be $500,000 of estate taxes to pay. As a result, the vast majority of my clients who are married couples have an estate plan that creates a “Bypass Trust” when the first spouse dies, to bypass estate taxes. The Bypass Trust will hold the deceased spouse’s assets, and use the deceased spouse’s Exemption. The survivor is the beneficiary of the Bypass Trust but the assets in the Bypass Trust are not taxed when the survivor dies. This allows the survivor to use all the assets during his or her lifetime, and to use the Exemption of both spouses; this approach essentially doubles the amount that can pass free of Estate Tax.
There has always been a potential downside to the use of the Bypass Trust, and that is: while the assets in the Bypass Trust escape Estate Tax at the death of the survivor, they also do not receive a new ”stepped up” income tax basis at that time. Because the Estate Tax was taxed at up to 55% versus capital gains at 20% (plus California capital gain taxes around 9+%), it was almost always better to avoid the Estate Tax and forgo the “stepped up” basis at the death of the survivor. With the current Estate Tax rate of 40%, and California capital gain tax rates bumped up to 13.3%, this is not such an easy choice now.