Minimizing estate tax with a bypass trust

March 21, 2008

My estate is worth about $3 million now. I was planning to leave it all to my wife if I die before she does, since anything going to her will escape federal estate tax. Then she'd leave whatever remains to my son after her death. But a friend says the government will take more tax that way. Why?

My estate is worth about $3 million now. I was planning to leave it all to my wife if I die before she does, since anything going to her will escape federal estate tax. Then she'd leave whatever remains to my son after her death. But a friend says the government will take more tax that way. Why?

If you leave the whole $3 million to your wife it will escape tax when you die, but part of what's left when she dies could be taxed. To avoid that you need to take advantage of the federal estate tax exemption. That allows a certain amount to pass to someone other than your spouse free of estate tax. You can do this by setting up a bypass (credit shelter) trust for your son to receive part of your estate-as much as you want, up to the amount of the exemption (currently $2 million). When your wife dies, the part of her estate that's equivalent to the exemption will also pass to your son tax-free.

The tricky part is deciding how to divide your estate, in part because the estate tax exemption will change within the next few years. An estate planning attorney can help you establish the best plan to provide for your family while minimizing the tax bite.