The Bypass Trust: To "B" or Not to "B"?

For many years, estate planners recommended planning that involved an "A/B trust" structure whereby assets of the first spouse to die equaling the estate tax exemption in value would end up in a trust to preserve that spouse's estate tax exemption. This prevented the surviving spouse from being "left with the couple's assets, but only their own individual exemption." Depending on a number of factors, this strategy could potentially save millions of dollars in estate taxes.

The costs of this trust, which is known by many names including a "B Trust," "Credit Shelter Trust," "Family Trust," or "Bypass Trust," are not insignificant. The surviving spouse's access to the assets of the B Trust are necessarily restricted, tax returns must be filed each year the trust is in existence and has income, legal responsibilities are imposed on the surviving spouse or a non-spouse trustee for trust management, and there is no step-up in basis for the B Trust assets at the surviving spouse's death.

Until recently, these costs could easily be justified by the potential estate tax savings. After the American Taxpayer Relief Act, however, the law allows the deceased spouse's unused exclusion amount to be transferred to the surviving spouse without the need for a B Trust. The unused exclusion must be calculated, and an election to transfer the unused exclusion made, on a timely filed estate tax return of the first spouse to pass away.

Rev. Proc. 2014-18, effective January 27, 2014, allows for an extension of time to make this "portability" election for decedents who passed away in 2011, 2012, or 2013 and who were survived by a spouse. Such elections, made in conjunction with the filing of an estate tax return, must be filed by December 31, 2014.

There are still benefits of a B Trust, namely, asset protection for the assets held by the trust, asset appreciation value that is excluded from estate tax, and greater certainty that the bequests contemplated by the first spouse to die will be carried out. However, the estate tax benefits to the B Trust have been reduced.

While it a good idea for everyone to review their estate plan every few years anyway, it is particularly appropriate for those with A/B trust provisions included in a revocable trust package to review whether that is still appropriate. For surviving spouses stuck managing a B trust that is no longer justified, it is appropriate to have the trust reviewed to see if it can be modified to better achieve that spouse's objectives.