When one spouse dies leaving significant assets, a primary goal is to pass those assets on to the surviving spouse in such a way as to minimize the survivor’s taxable estate when he or she eventually passes away. Competing with this goal are income tax goals. When the first spouse dies, their executor can allocate $1.3 million in additional basis to assets passing to any beneficiary, including a bypass trust. The executor can allocate another $3 million in additional basis to assets passing to the surviving spouse.

So, a tension arises between fully funding a bypass trust to get the maximum estate tax benefit and taking full advantage of the spousal additional basis by allocating assets to the marital share. Which is the better course of action? It depends on the circumstances.

Take, for instance, an estate where the husband has died leaving assets valued at $5 million with a basis of $700,000. Let’s look at two possible scenarios:

In scenario one, it’s not likely that the wife will have a taxable estate and she’s planning to sell the assets in the near future. Under these circumstances, income tax goals move to the forefront, and the better choice is probably to allocate the assets to the marital share to take full advantage of the wife’s $3 million in additional basis. By allocating the assets to the marital share, the basis of the assets can be raised from $700,000 to $5 million. ($700,000 + $1.3 million additional basis + $3.0 million spousal additional basis)

Contrast this with scenario two, in which the wife is expected to have a taxable estate, and her plan is to hold on to the assets long-term. In this situation, the primary goal becomes estate tax avoidance, so the better choice is to allocate the assets to the bypass trust, minimizing the wife’s taxable estate.

The tension between fully funding the bypass trust and fully utilizing the spousal additional basis can only be resolved by taking a close look at the facts and determining which goal, minimizing estate tax or reducing income tax, takes priority. If the survivor’s estate is likely taxable, with rates up to 55%, the estate tax considerations will likely take priority.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
6050 Santo Road, Suite 240
San Diego, CA 92124
(800) 846-1555
www.aaepa.com