Portability, Bypass Trusts, Basis Step-ups, etc.

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grayparrot
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Portability, Bypass Trusts, Basis Step-ups, etc.

Post by grayparrot »

I understand that some of this may be beyond scope, but I thought I'd see what thoughts boglehead might have about whether I"m understanding things correctly.

My parents, both in their early 70s, are grandmaster level procrastinators and have not yet prepared any estate plans, despite a net worth of around $5MM. I have been on their case to do so for many years, and for a long time it seemed that the best strategy was to prepare a standard a/b trust, to minimize the taxable estate. Now it seems that their delay may actually have helped them outlast the need for trusts.

It seems that because of 1) the permanent increase in the estate tax exemption and 2) the permanent implementation of the exemption portability, the case for the trusts might have been eliminated for couples who don't forecast a total taxable estate of more than $10MM. I just wanted to pick the brains of any experts out there to make sure that I'm understanding the intricacies correctly.

First, one major drawback of trusts as I understand them is that they do not receive a step up in basis at death; although in the past it was still desirable to give up the step-up and pay the (low) capital gains tax instead of the (high) estate tax, now that portability allows a couple to pass $10MM estate tax free to beneficiaries, the loss of a step up seems like it is now generally a dealbreaker for trusts (except for other considerations like protecting certain beneficiaries from previous marriages, etc.) Am I understanding this correctly? (I did also hear that there is some technique called a QTIP election which could allow a decedent's trust to receive the step up, but I don't understand this process.)

My remaining concern is about avoiding probate; that seemed a benefit of trusts, but I'm assuming the effect can be the same with appropriate TOD/POD titling on major assets?

I appreciate any thoughts and suggestions; I'm assuming that there are others out there in similar circumstances who either have already figured out the best course based on the new rules, or who would also appreciate getting current on strategies that are now most appealing.
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R-Man
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by R-Man »

I arrived at the same conclusion as you on the need for a A/B trust in wills. I had previously set them up several years ago when the estate tax laws were much stricter. I am now in the process of removing the trusts from our wills since we are in no danger of exceeding the exemption amounts. There are too many negatives to continue. There are still reasons for the trusts even if the estate is below the exclusion amount. I suggest reading an article (Should planners bypass the bypass trust?) in the July issue of the Journal of Financial Planning for full details. http://www.fpanet.org/journal/
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letsgobobby
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by letsgobobby »

State estate taxes? In my state that is only $4M per couple, non-indexed to inflation.

Proper titling of assets certainly avoids probate. What about those you can't achieve this with?

Trusts can also help the heirs reduce exposure to creditors.

The point being, it's more than just the federal estate tax exemption which needs to be considered.
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Dale_G
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by Dale_G »

A few months ago I moved all of our A/B trust assets to our individually owned accounts and had the pour over will rewritten.

Portability (at the cost of having to file a federal estate tax form) removed any tax advantages of the trust. The surviving spouse is very unlikely to remarry and there were no issues with heirs' spouses (none now and none expected).

There is a loss of asset protection (after the death of a grantor). But the complexity of the trusts and probable need for some ongoing legal and accounting help for the beneficiaries after my death seemed to outweigh any remaining benefits of the trust in our situation.

We did not revoke the trusts, if the law changes, we can always go back.

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littlebird
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by littlebird »

My spouse and I have a trust so that a successor trustee or trustees can step in and administer our finances should we become incapable of handling them on our own, without the necessity for court proceedings.
ourbrooks
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by ourbrooks »

I'd worry far more about the lack of a will than about trusts. If they're such procrastinators on estate planning, what are the odds that they've titled everything correctly? Chances are high that they've got some significant asset which is not titled properly and which will force probate. In California and Illinois, if the estate has unassigned assets worth more than $100,000 then you must do a full probate; in Texas, that amount is only $50,000. Probate without a will is, if nothing else, time consuming and probably costly.

If they don't have a will, then setting up a simple one shouldn't cost that much. Later, you can go back and set up trusts, etc. if desired.
bsteiner
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by bsteiner »

I think there's some confusion between credit shelter (bypass) trusts and revocable trusts.

Revocable trusts are overhyped and oversold, and for most people, in most states, are not necessary, and tend to be a distraction. In most cases, in most states, probating a Will is not particularly difficult, expensive or burdensome, and not worth "avoiding" any more than you would drive an extra half hour to avoid a 50 cent toll. You can put the same dispositive provisions, including the credit shelter trust and the trusts for children, in your Will. California may be an exception.

Transfer on death is rarely a good idea. Our clients almost always provide for their children in trust rather than outright, to keep the inheritance out of the children's estates, and to protect against their children's creditors and spouses. However, if the assets pass to the children as transfer on death beneficiaries, that will defeat the trusts for the children created under the Will.

For many years, the typical Will for a married person contained a credit shelter (bypass) trust for the Federal exempt amount, so that this amount would be available for the spouse, but would not be included in the spouse's estate. With a $5.25 million exempt amount and portability, very few estates will pay Federal estate tax. As a result, there's a tradeoff between the benefits of the credit shelter trust (it provides asset protection, portability is not being indexed for inflation, and is not available for generation-skipping transfer tax purposes or state estate tax purposes) and the cost and complexity (the higher income tax rates for trusts, the loss of the second basis step-up at the spouse's death, and the cost of preparing an income tax return each year for the trust).

In this example (a couple in their early 70s with about $5 million, and assuming that they're retired), in a state with no state estate tax, we would probably stay with the traditional approach, and create a credit shelter trust. One spouse could live another 20 years, so the trust will protect against the possiblity that the assets will grow faster than the indexing of the exempt amount (since the portability amount is not indexed for inflation). It will also allow for the use of both spouses' GST exemptions. If transfer taxes turn out not to be a major problem, the trust can always distribute its income (so that the income will be taxed to the beneficaries at lower income tax rates), and if there are any highly appreciated assets in the trust, the trust can distribute those assets to the spouse, while retaining the benefits of the trust for the remaining assets.

The same couple in a state having a state estate tax with a lower exempt amount might shelter only the state exempt amount. Sheltering the state exempt amount may save some state estate taxes at the surviving spouse's death.

Some states allow a state-only QTIP election and some don't. In a state that allows a state-only QTIP election, the Wills might contain a "gap" trust, for the difference between the state exempt amount and the Federal exempt amount. That trust would be in QTIP form. In other words, the spouse would receive all of the income from the trust. Note that this would throw the income from the gap trust into the spouse's estate for Federal estate tax purposes, but on these numbers the expectation would be that the spouse's estate won't be subject to Federal estate tax. This might be riskier if the couple had more than $5 million, or if they were younger.

In a state that has a state estate tax with a lower exempt amount, and doesn't allow a state-only QTIP election if a Federal return is filed to elect portability, the decision making is more complicated. On these facts, they might leave the excess about the state exempt amount to each other in a way that will qualify for the marital deduction even without a QTIP election, such as outright or a trust in which the spouse has a general testamentary power of appointment (in other words, where the spouse has complete control over who will get the trust assets upon his/her death). If the assets were substantially less, they could leave the excess about the state exempt amount in a QTIP trust, make a state QTIP election, and sacrifice portability. If the assets were substantially higher, they could shelter the Federal exempt amount, so as to minimize the estate tax at the surviving spouse's death, at the cost of as much as $478,182 of state estate tax.

Since the original poster's parents are worth $5 million, they should consult with a trusts and estates lawyer who is familiar with all of this.
MN Finance
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by MN Finance »

Agree with ourbrooks. The lack of any plan is far more worrisome than what the plan is, despite bsteiners always excellent summary. It's almost like LeBron sitting at home 5 min before tipoff wondering which Nikes to wear. I sure wouldn't want state intestacy laws determining where my assets go. At best its inconvenient, at worst its messy and financially damaging. Not to mention incapacity issues while alive, financial and medical. A simple set off documents should be inexpensive and not emotionally burdensome. They can always be amended
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Kevin M
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by Kevin M »

grayparrot wrote: First, one major drawback of trusts as I understand them is that they do not receive a step up in basis at death; although in the past it was still desirable to give up the step-up and pay the (low) capital gains tax instead of the (high) estate tax, now that portability allows a couple to pass $10MM estate tax free to beneficiaries, the loss of a step up seems like it is now generally a dealbreaker for trusts (except for other considerations like protecting certain beneficiaries from previous marriages, etc.) Am I understanding this correctly?
No, I don't think this is correct for a simple living trust. Assets in the trust are treated the same for tax purposes as before the trust was created. Where did you get this information?

IMO, a living trust is a good idea for residents of many states, including my state of CA, since probate can be expensive and time consuming. I have settled a couple of trusts (father and brother), and am glad I did not have to go through probate. One of the trusts included real estate, and the basis was stepped up.

I set up the trust for my brother using the Nolo Press book on trusts, and settled it myself after his death with no issues; no attorneys involved at any point. For my father's trust, I only used an attorney to file a document with the court to avoid any increases in property tax. Obviously more complex situations would require the use of an estate attorney.

I understand that probate is relatively easy and inexpensive in other states, but I see no point in involving attorneys and courts if not necessary. I'm sure many attorneys will disagree.

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MN Finance
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by MN Finance »

He's talking about estate taxes, so he's referring to a credit trust which isn't stepped up. Ie weighing estate tax to cap gains.
Goodman60
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by Goodman60 »

I'm no estate attorney and BSteiner ALWAYS gives good advice here. But it sounds like your parents are going to recoil at complexity. That being said, PAYABLE UPON DEATH/TRANSFERABLE UPON DEATH accounts probably is the easiest to understand, allows them continued lifetime control, and will at least be a "good enough" plan versus the current "no plan".
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by bsteiner »

Goodman60 wrote:I'm no estate attorney and BSteiner ALWAYS gives good advice here. But it sounds like your parents are going to recoil at complexity. That being said, PAYABLE UPON DEATH/TRANSFERABLE UPON DEATH accounts probably is the easiest to understand, allows them continued lifetime control, and will at least be a "good enough" plan versus the current "no plan".
Thanks for the kind words. However, the original poster's parents are worth $5 million. I think it's worth the cost and complexity (which isn't really that much) to protect $5 million. A couple in their 70s with $5 million is a routine estate planning situation. What if one of their children (i) has a creditor problem or is concerned about potential creditors, (ii) gets divorced, (iii) outlives his/her spouse and remarried, (iv) does well and has a taxable estate of his/her own, or (v) goes into a nursing home or needs other long-term care and could get Medicaid if not for his/her inheritance? These are reasonably foreseeable possibilities. When it's explained to them, almost everyone with $5 million, and most people with a good deal less than $5 million, are willing to accept the cost and complexity.

As for lifetime control, the surviving spouse can have effective control over the credit shelter trust; and after the surviving spouse's death each child can have effective control over his/her trust.
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by Goodman60 »

I don't disagree. But it would just seem that if they accumulated this much this late in life and still haven't made an estate plans, they're PROBABLY going to shy away from anything that seems complex. But if the OP can get them to do it, he certainly should. I'm just saying if he CANNOT, a simple POD plan is much better than no plan, esp now that a couple can leave $10M+ free of fed estate tax.
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Kevin M
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by Kevin M »

Some people aren't that interested in controlling, from the grave, assets they pass on to their children. But it's worthwhile to at least consider these issues, so thanks for bringing them up.

Kevin
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bsteiner
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by bsteiner »

Kevin M wrote:Some people aren't that interested in controlling, from the grave, assets they pass on to their children. But it's worthwhile to at least consider these issues, so thanks for bringing them up.
You don't have to choose between the estate tax and asset protection benefits of leaving money in trust versus letting the children have control. You can leave money to a child in trust and still let the child have control. The child can be a trustee of his/her own trust. The child can have the power to remove and replace his/her co-trustee (provided the replacement trustee is not a close relative or subordinate employee). The child can also have the power to appoint (give or leave) the trust assets to anyone he or she wishes (other than the child or his/her estate or creditors), both during lifetime and by Will.

The original poster's parents have $5 million. While the decision is ultimately up to the clients, we would very, very, very strongly urge them to provide for their children in separate trusts for their benefit rather than outright, with each child controlling his/her trust after a specified age (absent some special reason not to give a child control in a given case).
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by kaneohe »

bsteiner wrote:
You don't have to choose between the estate tax and asset protection benefits of leaving money in trust versus letting the children have control. You can leave money to a child in trust and still let the child have control. The child can be a trustee of his/her own trust. The child can have the power to remove and replace his/her co-trustee (provided the replacement trustee is not a close relative or subordinate employee). The child can also have the power to appoint (give or leave) the trust assets to anyone he or she wishes (other than the child or his/her estate or creditors), both during lifetime and by Will.
.
Can the child be sole trustee and still have asset protection? ......or must the child have a non-related co-trustee to get the asset protection?
bsteiner
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by bsteiner »

kaneohe wrote:Can the child be sole trustee and still have asset protection? ......or must the child have a non-related co-trustee to get the asset protection?
You've asked two questions. The first is whether the child can be the sole trustee and still have asset protection. A trustee who is a beneficiary can't participate in discretionary distributions to himself/herself, except as limited by an ascertainable standard (such as health, maintenance, support and education), or else the trust will be included in the beneficiary's estate. "Ascertainable" doesn't mean objectively ascertainable. It just means that a court can decide how much is appropriate.

The safest approach is to say that a trustee who is a beneficiary cannot participate in discretionary distributions to himself/herself for any reason. In that case, the child can be a trustee, but would need to add a co-trustee if he/she ever wanted a distribution.

Another approach is to permit the trustee/beneficiary to withdraw for an ascertainable standard. In that case, the child can be a trustee, and can withdraw for the ascertainable standard, but would need to add a co-trustee if he/she ever wanted a distribution beyond the ascertainable standard. Whether this exposes the trust to creditors to the extent of the ascertainable standard, or to Medicaid, may vary from state to state. While some lawyers draft this way, to avoid any doubt, I prefer to have a co-trustee, and to prohibit the child from participating in distributions to himself/herself for any reason. If the child has the power to remove and replace his/her trustee, the child will effectively control the trust.

The second question was whether the co-trustee has to be independent. This is a 2-part question. The first part is whether the initial co-trustee has to be independent. Some people prefer to have an independent co-trustee for gift tax reasons. This is because if the co-trustee has an interest in the trust, and the co-trustee votes to make a distribution to the child (or to the spouse in the case of a credit shelter (bypass) trust, there's some risk that the co-trustee could be treated as making a gift (since by making the distribution to the spouse, less money will remain in the trust). Assuming the trust is a discretionary trust, I think that the risk of a gift other than a nominal gift is sufficiently small that I'm willing to have an interested party as co-trustee. However, some people prefer to have an independent co-trustee for this reason.

The second part of the second question involves removing and replacing the co-trustee. Where the testator would have provided for the child outright but for estate tax and asset protection, he/she will give the child the power to remove and replace his/her co-trustee. In this case, we require that the replacement trustee be someone not a close relative or subordinate employee. If the child could remove his/her co-trustee and appoint a close relative as the replacement co-trustee, I think there's a significant risk that the trust would be included in the child's estate for estate tax purposes. This restriction doesn't apply if the child is filling a vacancy in the office of co-trustee upon the death or resignation of the co-trustee.
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by kaneohe »

bsteiner........thanks so much for that long and comprehensive reply. I didn't realize how many questions I was asking and I am not sure I fully understand all the implications of your response but I will bookmark and save your response for future reference.
Thanks again!
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grayparrot
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by grayparrot »

OP here; for some reason, I wasn't getting ongoing email alerts about replies to my post even though I'd set up my settings that way, so I only saw all these very helpful posts when I checked back to see why I wasn't getting any responses.

Anyway, I just wanted to say thanks so much for the thoughtful responses and helpful information; I greatly appreciate them!
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by MikeG62 »

bsteiner wrote:
Kevin M wrote:Some people aren't that interested in controlling, from the grave, assets they pass on to their children. But it's worthwhile to at least consider these issues, so thanks for bringing them up.
You don't have to choose between the estate tax and asset protection benefits of leaving money in trust versus letting the children have control. You can leave money to a child in trust and still let the child have control. The child can be a trustee of his/her own trust. The child can have the power to remove and replace his/her co-trustee (provided the replacement trustee is not a close relative or subordinate employee). The child can also have the power to appoint (give or leave) the trust assets to anyone he or she wishes (other than the child or his/her estate or creditors), both during lifetime and by Will.

The original poster's parents have $5 million. While the decision is ultimately up to the clients, we would very, very, very strongly urge them to provide for their children in separate trusts for their benefit rather than outright, with each child controlling his/her trust after a specified age (absent some special reason not to give a child control in a given case).
I am of the same opinion as bsteiner (not that it matters as he is the subject matter expert) as relates to using a trust(s) for the children of these two folks. We plan to use trusts for the money we will pass to our children for these reasons.

I have a related question though. Given portability and the increased personal estate tax exemption amount (current rules and cutoffs), does it make sense to place the assets of the first to die spouse in a trust vs. simply passing the 1st to die spouses assets to the surviving spouse and porting the deceased spouses personal exemption? In either case, the plan is to place all the assets in trust for our children once we are both deceased. Assume high seven figure net worth and couple in their mid-50's (but retired).

I see the decision tree looking like this.

Factors weighing in favor of portability:

1. Ease of administration
2. Setup cost
3. Ongoing cost
4. Ongoing tax efficiency - Although distributing all income from the trust (including cap gains) may get to the same place
5. Step-up on death of 2nd to die spouse

Factors weighing in favor of using a Trust:

1. Future growth in assets free of estate tax (but subject to income tax) - there is probably a point where one outweighs the other, but it's hard to project with much certainty
2. Creditor Protection - not a big factor as the 2nd to die spouse is not likely to have creditor issues
3. Protect assets from new spouse on remarriage - although this can probably be achieved with portability and a pre-nup
4. 1st to die spouses ported exemption lost if SS spouse is pre-deceased by new spouse
5. Preserves GST exemption

I'm leaning toward portability (with the SS understanding the need for a pre-nup should they remarry or even not marrying so as not to lose the 1st to die spouses ported exemption), but accept that reasonable minds could differ.

What do you all think?
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bsteiner
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by bsteiner »

MikeG62 wrote:... Given portability and the increased personal estate tax exemption amount (current rules and cutoffs), does it make sense to place the assets of the first to die spouse in a trust vs. simply passing the 1st to die spouses assets to the surviving spouse and porting the deceased spouses personal exemption? In either case, the plan is to place all the assets in trust for our children once we are both deceased. Assume high seven figure net worth and couple in their mid-50's (but retired).

I see the decision tree looking like this.

Factors weighing in favor of portability:

1. Ease of administration
2. Setup cost
3. Ongoing cost
4. Ongoing tax efficiency - Although distributing all income from the trust (including cap gains) may get to the same place
5. Step-up on death of 2nd to die spouse

Factors weighing in favor of using a Trust:

1. Future growth in assets free of estate tax (but subject to income tax) - there is probably a point where one outweighs the other, but it's hard to project with much certainty
2. Creditor Protection - not a big factor as the 2nd to die spouse is not likely to have creditor issues
3. Protect assets from new spouse on remarriage - although this can probably be achieved with portability and a pre-nup
4. 1st to die spouses ported exemption lost if SS spouse is pre-deceased by new spouse
5. Preserves GST exemption. ...
A good summary. Also, in most states that have a state estate tax, there's no portability for state estate taxes.

A middle ground (with its own set of advantages and disadvantages) is all to the spouse, with a disclaimer credit shelter trust as backup. That lets the surviving spouse make the decision. However, the surviving spouse won't have as much control over a disclaimer credit shelter trust as he/she would have over a mandatory credit shelter trust. In particular, the surviving spouse can't have a broad special power of appointment over a disclaimer credit shelter trust.
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by MikeG62 »

bsteiner wrote:
A good summary. Also, in most states that have a state estate tax, there's no portability for state estate taxes.

A middle ground (with its own set of advantages and disadvantages) is all to the spouse, with a disclaimer credit shelter trust as backup. That lets the surviving spouse make the decision. However, the surviving spouse won't have as much control over a disclaimer credit shelter trust as he/she would have over a mandatory credit shelter trust. In particular, the surviving spouse can't have a broad special power of appointment over a disclaimer credit shelter trust.
Thanks Bruce. Good point on state estate tax, although in NJ it appears our tax may soon be going the way of the dinosaur. Having said that, we may not always live in a state without a state estate tax, so the point is well taken.

Our wills as structured are set up exactly as you suggest - all to surviving spouse with disclaimer CST.

What I have been worrying about is that if I die first, my wife will likely stuggle to understand any of this (to disclaim or not to disclaim). Even with professional help, I worry that the decision is just not one where there is a clear right answer - if there were you might have offered one:-). While a professional can lay out the pro's and con's of each option, the surviving spouse needs the financial capacity to take that information/advice and make an informed choice. So I am trying to prepare a "what would Mike suggest I do if he were here" type of document, as I suspect that is precisely what she will say if she finds herself in this position.

So in furtherance of that objective, I have tried to do as much research as possible on this topic and in posting on this forum I was looking for (am getting) even more intelligence. I am very thankful and appreciative to get the views of someone with your depth of knowledge and expertise in this area. I think it confirms what I have been thinking - no right answer, preserve flexibility when the time comes and try and at least highlight for my wife how I looked at the options. I don't think there is more help I can provide in anticipation, for the reasons indicated as well as the fact that it's impossible to know now what the estate tax laws will look like when I die.

It sure is interesting stuff.

Thanks,

Mike
Last edited by MikeG62 on Wed Nov 16, 2016 6:53 pm, edited 2 times in total.
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Leesbro63
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Re: Portability, Bypass Trusts, Basis Step-ups, etc.

Post by Leesbro63 »

As to state inheritance/estate taxes: It's my understanding that if the surviving spouse can and does take the income from the credit shelter trust, Pennsylvania inheritance tax is not due as it's not considered a completed transfer. (And the surviving spouse can move to places like Florida, in the meantime, before he or she does and avoid PA inheritance tax altogether if the situation warrants that).
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