Q. My wife and I created a Living Trust about 15 years ago. She recently died and I just re-read our trust. To my surprise, it requires that her half of our assets go into a Bypass Trust and greatly limits my access to that portion. This comes as a surprise, as we always intended everything to go to the survivor without restrictions. Am I now stuck with this arrangement or is there anything I can do?
A. There is something you can do, but it’s helpful to first understand the background: At the time that you and your wife created your trust the tax laws were quite different than they are today. Back then, the estate tax exemption was only $675,000 per person, and the first spouse’s exemption died with her unless the couple had signed a trust directing the deceased spouse’s share of assets into a ByPass sub-trust. (The ByPass was sometimes called a “B Trust”, Credit Shelter Trust, Family Trust, or Exemption Trust). This Bypass sub-trust was designed to preserve the first spouse’s exemption so that – at the survivor’s later death – their two exemptions could be combined, thereby doubling the assets that the couple could pass estate tax free to their children or other beneficiaries. That appears to be your situation.
However, these trust “split” arrangements came at a price: The survivor no longer had unrestricted use of the decedent’s share of marital assets, was required to keep separate accounts and was obliged to file fiduciary income tax returns each year for the ByPass Trust. Further, the assets placed into the Bypass portion usually did not get a second “step up” in tax basis upon the survivor’s death, and the trust split interfered with Medi-Cal planning if nursing care was needed. Most surviving spouses found these restrictions onerous.
With the new tax law, the individual exemption has been increased to $5,490,000 per person (in 2017), and a surviving spouse can now elect to preserve any unused portion of the predeceased spouse’s exemption for later use in combination with the survivor’s own exemption, effectively doubling that exemption to $10,980,000 for a married couple, and all without the necessity of a ByPass Trust. Thus, these older trusts are no longer necessary for most couples. The problem is that many couples still have these outdated trusts in place and, like you, only learn of the trust split requirement upon the death of their spouse, when the terms of the trust can no longer be changed by signing an amendment.
Good news: While the terms of your trust cannot now be changed by you, alone, there is still a remedy: you can petition the superior court for an order reforming the trust to eliminate this restrictive trust split requirement. Your court petition would be based upon “changed circumstances” that were not known or anticipated at the time the original trust was created. Since most of these trusts were created years ago for tax savings purposes, the change in tax law dramatically increasing the exemption usually qualifies as the requisite “changed circumstances”.
In our experience, judges have been receptive to this analysis and have issued orders reforming these older trusts to eliminate the sub trust requirement, so as to permit all assets to go to the survivor. The key is to petition the court for relief soon and before you take steps to split assets and/or file tax returns. We suggest reviewing these matters with an estate planning or elder law attorney to see if you might qualify for judicial relief, and thereby accomplish the result that you and your wife originally intended.