California Society of CPAs / Estate Planning / CalCPA Discussion Forum / Unfunded Bypass trust / Latest Posts

RE: Unfunded Bypass trust

John Jacobson — Thu, 02 Oct 2008 21:08:15 GMT

I think everyone is on the same page. A lot depends on the wording of the trust.

Put yourself in the shoes of a child from a prior marriage suing the surviving spouse's estate or the terminating trust to fund the bypass trust.

If the bypass trust was the pecuniary amount, and it was obvious that the estate on the first death was more than twice the exemption equivalent amount, then the IRS auditor could be talking about a quick and dirty way of calculating the survivor's taxable estate. Legally, it is the liability from the terminating trust to the bypass trust.

But what if the bypass trust was the residue? My guess is the IRS auditor's theory is that the surviving spouse breached the trust, and had a liability to repay, estimated by the value of the exemption equivalent amount at the first death. "Breach" may mean not being able to account for the decedent spouse's interest in the community, as opposed to actually removing the assets from the trust. (But if the trustee can account for some assets, like realty, then the estimated value could change.) If the trustee cannot account for what comprised the decedent spouse's interest in the community, the only alternative is to quantify it as a $$ judgment.

A similar fact situation happened in a West Virginia case (I don't remember the cite) decided a few years ago, in which the s/s took most of the assets out of the bypass trust, titled them into his own name, and mixed them with his own. (He was a day trader.) His children filed the 706 without any liability back to the trust, and then amended the return to show the liability. Interestingly, the court denied the deduction because the trust did not file a timely creditor's claim in the decedent's probate estate.

If you can account, and by account, I mean specifically identify the decedent's interest in the community and what happened to it since death, I don't think the trust has been breached in your fact situation. It is only a matter of accounting for each half of the community and accomplishing the next steps. So including the first decedent's assets in the surviving spouse's taxable estate wouldn't follow. (Note also that including the first decedent's assets in the estate means they would be stepped up at the second death. That does not make sense unless there is a breach.)

RE: Unfunded Bypass trust

Mary Kay Foss — Thu, 02 Oct 2008 14:30:33 GMT

Retired estate tax attorney, Joe Stemach, at a CalCPA program said that when the trust is unfunded at the second death, he (and his colleagues) would allow a deduction for a liability equal to the amount that should have been funded. Many people were upset because he said that no allowance would be made for any appreciation that had occured between the first and the second death.

I've prepared delinquent 706 forms when the surviving spouse thoght she didn't have to do anything when her husband died because "everything was in a trust to make it simple." In the last one I prepared, there was a gain on funding because the surviving spouse received more than she would have with a timely funding.

RE: Unfunded Bypass trust

Mike Hagedorn — Thu, 02 Oct 2008 09:28:34 GMT

I attended a Cal Society Estate conference many years ago where an IRS agent named Richard Ludlum, spoke to the audience. He made the statement that if the bypass trust had never been funded five to ten years after the first spouse died, then the estate representative better have a good excuse, or otherwise he will include all assets in the second to die's estate.

With the first spouse dying in 2006 and the second dying in 2008, it seems that one could make an argument that it wasn't administratively possible to fund the trust, especially if the surviving spouse was temporarily the trustee.

I would divide the trust assets 50/50, get an EIN for the bypass trust, and file a first and final return for it.

I would not file a 706 for the second to die, due to the gross assets being under the filing amount.

RE: Unfunded Bypass trust

John Jacobson — Wed, 01 Oct 2008 20:17:51 GMT

Wow, Richard. You always have the "good" ones! Please register!

A few of us from the L.A. Chapter Estate Planning Committee could speak with you at length about this. Let me offer a few comments and ask a few questions:

1. My understanding from listening to IRS attorneys at our Feb meeting over the years is that they expect actual title transfer and funding eventually. It is not in your client's interest to ignore the terms of the trust for expediency.

2. Does the bypass trust get the pecuniary amount, or does the survivor's trust get a pecuniary amount (if necessary) to lower the estate tax to zero?

3. While the assets are in the terminating living trust, the separate property and 50% community interest of the survivor get taxed to the survivor, and the separate property and 50% of the community interest of the decedent get taxed to the trust. You probably have amended returns to file.

4. How hard is it to account for everything since the first death?

5. Google "stale trust" for one of Hartog's articles about this. His treatise is very useful for attorneys and accountants practicing in this area.