In December of last year, President Obama turned the standard estate plan upside down when he signed the Tax Relief Act of 2010. In addition to a record $5 million applicable exclusion amount and continued 35% top rate, the estate tax included a brand new concept that may force your clients to re-evaluate their estate plan.

That concept is the Deceased Spouse Unused Exclusion Amount (DSUEA). Advisor’s Journal covered the DSUEA shortly after the concept was introduced [Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122)]. In that article, we concluded that the DSUEA not only makes bypass trusts unnecessary, but may even hurt an estate’s beneficiaries by reducing the basis of assets they receive from the bypass trust. We hinted at one solution to the bypass trust problem—disclaimers. Here we’ll discuss a particular solution to the bypass trust problem, the so-called “A-B Bypass Trust.”

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the new estate tax in Advisor’s Journal, see IRS Finally Issues Guidance on 2010 Estate Tax (CC 11-160), Does the New Estate Tax Make the Bypass Trust Obsolete? (CC-10-122), & Obama Tax Agreement Passed by House (CC 10-117).

For in-depth analysis of the estate tax, see Advisor’s Main Library: Estate, Gift and GST Taxes

Why is this Topic Important to Wealth Managers? This blogticle concludes our weeklong series on the unified estate and gift tax as well as the portability of the spousal credit. This week we discussed the estate and gift tax in detail so that wealth managers are well prepared to address client planning needs.

How the DSUEA will be treated after 2012 is uncertain, but wealth managers should consider the possible ramifications of the returning sunset and how it may affect your clients’ estate planning. As we have seen Congress may extend the sunset date, revert the rules to a prior act in time, or treat the DSUEA as if it never existed.  Not surprisingly because there are currently no provisions to address the consequences if the law is not renewed in 2013, long term planning uncertainty still exists in the gift and estate tax area.

On the one hand, if Congress extends the DSUEA, then bypass trusts will likely remain unnecessary for estate tax purposes. Spouses will have the continued opportunity to utilize the DSUEA and take advantage of its many benefits, such as making gift transfers to heirs or establishing trusts that take full advantage of the increased exemptions.

On the other hand, if Congress does not take action by 2013, the Bush tax cuts – and the modifications made by the Tax Relief Act of 2010 – will be treated as if they had never been enacted. Under the latter scenario, the estate tax would revert back to the 2001 level which amounts up to a $1 million exemption, with a maximum rate of 55%. Additionally, if no further action is taken before the end of 2013, the portability feature would no longer be available at that time. Thus, if the DSUEA ceases to exist after December 31, 2012, the bypass trust will likely once again become an integral part of the estate planning process.  In light of the new DSUEA concept, existing bypass trusts should be examined to determine whether the benefits of a bypass trust outweigh the loss of step-up basis that results from their use.

Series Summary

The increased estate and gift tax exemptions along with unification of the gift and estate tax created changes to the treatment of estate and gift taxes generally. The new law reinstated the estate tax but provides for an exemption of $5 million with a top tax rate of 35%. Moreover, the new DSUEA created an even higher combined exemption amount for some spouses. Thus, the provisions in the TRA of 2010 provide one planning route that may be examined as the optimal path for some married couples. As always with tax law, what is appropriate for each client should be determined on a case-by-case basis.

For more information on the implications of the new estate and gift tax in particular client situations please feel free to contact our panel of experts.

Next week’s blogticles will again address issues surrounding wealth management practice.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? This blogticle represents part four of five in a series on the unified estate and gift tax as well as the portability of the spousal credit. Most wealth managers are aware of the new changes to the federal estate and gift tax structure with the unification and increased exemption amount of five million dollars. This week we discuss the estate and gift tax in detail so that wealth managers are well prepared to address client planning needs.

Generally the purpose of a bypass trust is to fully utilize a deceased spouse’s exclusion amount which is now also accomplished by the statutory DSUEA. Thus, there is no need to preserve the first spouse’s exclusion amount since the surviving spouse’s estate will be able to utilize the first spouse’s exclusion amount without use of a trust. In short, the bypass trust is no longer usually necessary for estate tax purposes.

Both the DSUEA and bypass trust will fully utilize the first-spouse-to-die’s exclusion amount, so why not use an A-B trust arrangement? After all, Congress could eliminate the DSUEA in 2012 as easily as it introduced it in 2010. The A-B trusts are the marital deduction trust (A), and the credit shelter trust (B).

Yet there is a very good reason to think twice before using a bypass trust in 2011 and 2012 (and in later years if the DSUEA concept sticks around). Assets of the first spouse to die that are placed in a bypass trust do not receive a step-up in basis at the death of the second spouse; however, assets that pass untaxed in the second spouse’s estate due to the first spouse’s DSUEA will receive a step-up in basis, which can result in a very significant income tax savings when beneficiaries of the surviving spouse’s estate sell property received from that estate.

Although use of a bypass trust in 2011 and 2012 is unnecessary—and even counterproductive— for estate tax purposes, existing bypass trusts do not necessarily need to be eliminated from the estate plan. Estate tax “certainty” extends only through 2012, and the DSUEA may disappear when the next Congress takes its turn with the estate tax. If the DSUEA is eliminated, the bypass trust will again become an important tool for estate planning.

Rather than remove the bypass trust from the will, the trust can be dealt with if the testator dies in 2011 or 2012 through the use of disclaimers. If the standard A-B trust arrangement is kept in place while the DSUEA is in effect, and the surviving spouse is named as residual beneficiary of the trust, the gift to the bypass trust can be disclaimed and the surviving spouse will take the property. Then, at the surviving spouse’s death, the DSUEA component of the last-to-die spouse’s exclusion amount will capture the first-to-die spouse’s unused exclusion amount.

Importantly, beneficiaries will receive property covered by the DSUEA with a stepped-up basis, unlike property received from a bypass trust. [1]

Under the new estate tax regime, the estate’s applicable exclusion amount is equal to the basic exclusion amount plus the DSUEA.[2] More specifically, the Tax Relief Act of 2010 sets the DSUEA for a surviving spouse of a deceased spouse dying after December 31, 2010, as the lesser of: (A) the basic exclusion amount, or (B) the excess of – (i) the basic exclusion amount of the last such deceased spouse of such surviving spouse, over (ii) the amount with respect to which the tentative tax is determined under IRC Section 2001(b)(1) on the estate such deceased spouse.[3]

In sum, the DSUEA is “portable” in nature, meaning that it allows a surviving spouse to utilize his or her deceased spouse’s applicable unused exclusion amount.[4] It is also important to note that the portability feature does is not apply to the unused GST tax exemptions of a pre-deceased spouse.[5]

Tomorrow’s blogticle will continue our weeklong series on the gift and estate tax.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Robert Bloink, Esq., LLM & Professor William H. Byrnes, Esq., LL.M., CWM, Selected Provisions and Analysis of the Tax Relief Act of 2010, 8, The National Underwriter Company (2011).

[2] IRC Sec. 2010(c).

[3] TRA of 2010 § 303(a)(4). See also IRC Sec. 2010(c)(4).

[4] TRA 2011 §303(a).

[5] U.S. Congress. Joint Committee on Taxation. General Explanation of Tax Legislation Enacted in the 111th Congress, 554 (JCS-2-11). Text from: Committee Reports. Available at: http://www.jct.gov/publications.html?func=showdown&id=3777 (last accessed April 6, 2011).

The estate tax is scheduled to explode in 2011. Analysts have assumed for years that Congress would act to fix the estate tax before it expired in 2010 and reverted to its pre-2001 levels in 2011, but it is looking more and more likely that the current Congress will hand the problem off to the next Congress on January 11, 2011. With the election coming on November 2, 2010, time is short for the 111th Congress to act. Although movement during the lame duck session is possible, it is not likely to generate any positive action on the estate tax.

Whether Congress acts on the estate tax or not, 2011 will likely bring drastic changes to the estate tax, requiring your clients to do significant tinkering on their estate plans. In the interim, estate planning professionals will continue to use disclaimer planning as a stop gap measure to deal with 2010′ s estate tax uncertainty. For instance, rather than split an estate’s assets between credit shelter and marital deduction trusts—which is unnecessary when there is no estate tax—all of the assets are devised to the spouse or the marital deduction trust.  The surviving spouse can then disclaim up to the tax-free amount— … Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the estate tax conundrum in Advisor�s Journal, see Estate Tax Chaos (CC 10-02).

For in-depth analysis of the federal estate tax, see Advisor�s Main Library: Section 2 A—Overview Of The Federal Estate Tax And Its Calculation.

We invite your questions and comments by posting them below or by calling the Panel of Experts