Portability Versus a Bypass Trust: Estate Tax Savings and Lost Basis Step-Up
Robert and Linda are U.S. citizens married for 40 years and live in Florida, a common-law state. Robert dies in 2024 with $9,000,000 of assets; Linda has $13,000,000. Robert’s will leaves everything outright to Linda. Robert made no taxable gifts, and his executor is considering whether to elect portability. Alternatively, Robert’s will could fund a bypass trust with his $9,000,000. The assets Robert would place in the bypass trust have a $1,000,000 basis before his death. By Linda’s death, those assets are expected to be worth $18,000,000; Linda’s own assets are expected to remain $13,000,000. Assume the 2024 estate and gift exclusion is $13,610,000, no state estate tax, and a 40% federal estate tax rate. Linda wants to minimize total transfer and income taxes.
1. Compute the deceased spousal unused exclusion (DSUE) and Linda’s available exclusion if portability is elected.
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Robert’s estate is $9,000,000, and his available exclusion is $13,610,000. Because Robert made no taxable gifts, his unused exclusion is:
- $13,610,000 − $9,000,000 = $4,610,000 DSUE
If Robert’s executor timely elects portability on Form 706, Linda’s available exclusion becomes:
- Linda’s own exclusion: $13,610,000
- Plus DSUE: $4,610,000
- Total: $18,220,000
The portability election must be made on a timely filed estate tax return, even though Robert’s estate is below the filing threshold. Missing the election forfeits the $4,610,000 DSUE.
2. Compute the estate tax at Linda’s death with portability versus with a bypass trust.
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Portability scenario. All assets are included in Linda’s estate:
- Bypass assets grown to $18,000,000
- Linda’s own assets: $13,000,000
- Total estate: $31,000,000
- Available exclusion: $18,220,000
- Taxable estate: $12,780,000
- Estate tax at 40%: $5,112,000
Bypass trust scenario. Robert’s $9,000,000 funds a bypass trust that is not included in Linda’s estate:
- Linda’s estate: $13,000,000
- Available exclusion: $13,610,000
- Taxable estate: $0
- Estate tax: $0
The bypass trust saves $5,112,000 of estate tax at Linda’s death.
3. Compare the income tax cost from the lost basis step-up and recommend which approach Linda should use.
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Basis comparison.
- With the bypass trust, Robert’s assets receive a step-up to $9,000,000 at his death. They do not receive a second step-up at Linda’s death. If the heirs sell at $18,000,000, the gain is $9,000,000.
- At a 23.8% combined capital gains rate, the income tax cost is $9,000,000 × 23.8% = $2,142,000.
- With portability, the assets are included in Linda’s estate and receive a second step-up to $18,000,000 at her death. The heirs would owe no income tax on that appreciation.
Net comparison.
- Estate tax saved by bypass trust: $5,112,000
- Income tax cost from lost step-up: $2,142,000
- Net advantage of bypass trust: $2,970,000
On these assumptions, the bypass trust is better because the estate tax savings exceed the lost income tax basis. However, Linda should revisit the decision if the assets are likely to grow much less, if the heirs are tax-exempt or have low capital gains rates, or if the estate tax exclusion changes. Portability is simpler and preserves a second step-up, but it costs more estate tax here.