April 2, 2021

Traditional Tax Planning versus Flexible Tax Planning

Traditional estate planning typically focused solely on avoiding state and federal estate tax. This made sense given the tax laws at the time. However, the traditional tax formulas used in estate planning documents have caused issues given the current tax climate. 

For instance, planners often used a tax formula that required the full $1,000,000 to be transferred into a bypass trust to avoid state estate tax. Unfortunately, when the surviving spouse passed away, the beneficiaries ended up facing an income tax liability that exceeded what they saved in estate taxes. 

Part of the problem is that Oregon does not have a special capital gains rate. Therefore, the state and federal capital gains rate (combined as high as 29.9%) far exceeds the Oregon estate tax rate (sliding scale of 10-16%). In fact, Oregon has the third highest capital gains rate in the country. 

By placing $1,000,000 of assets into the bypass trust, those assets were ineligible for a step up in basis to the fair market value as of the date of the survivor’s death. As a result, when the beneficiaries sell the assets that were held in the bypass trust, they have to pay capital gains on the difference between the fair market value on the date of the first spouse’s death and sale price. If the assets had not been held in a bypass trust, they would have only paid tax on the difference between the fair market value as of the date of the second spouse’s death and the sale price. 

As you can imagine, this difference can be quite significant if it is a highly appreciated asset. Julia has an advanced degree in taxation (LL.M. Tax), which enables her to properly guide clients through the potential pitfalls in their estate plan while ensuring they build in maximum tax flexibility.