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Bypass Trust and Your Estate Plan
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Bypass Trust Pros and Cons

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What is a Bypass Trust

How a Bypass Trust Works

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Do you ever wonder where your money will go when you die? Well, there are only three places: your descendants, the federal government, or your charity via a charitable remainder trust. You can control what your descendants and or charity get; the government could scoop up the remaining amount. Lucky for you, there are things you can do to limit the taxes your estate owes. 

Setting up a trust allows you to give assets more flexibly than just passing them on to the beneficiaries. Among the many benefits of setting up a trust is to minimize estate taxes. 

In a marriage, a spouse can leave his money to his wife without facing any estate taxes. That’s because husbands and wives are entitled to unlimited marital deductions. 

However, that money is included as part of the wife’s estate. If she doesn’t spend it all before she passes away, her estate may owe taxes on all or some of the endowment. 

That’s where a bypass trust can help. If spouses simply pass estates to their children, they will be taxed at the present estate tax rate, which right now is like 40% for inheritance above $1 million. Estate tax credits and gifts can help reduce some of the tax burdens, but if you own a large estate, you may want to try and reduce that tax bill as much as is permitted. 

What is a bypass trust? 

A tax bypass trust, aka an exemption trust or an A/B trust, is intended to decrease or eliminate a married couple’s estate tax obligation. It’s typically set up as an irrevocable trust so that without the consent of the trust recipient, it may not be amended or invalidated. It holds the property of the first spouse to die. However, the surviving spouse still retains access to the assets in the trust. For example, they can use the trust income and principal to settle medical bills. 

As already mentioned, a person may leave their estate to their spouse without incurring taxes on specific properties in case of death. But if the second spouse passes away and leaves the estate to the kids, any asset beyond the $11.58 million exemption ceiling is taxed at rates of up to 40%. That means a single spouse should not leave their children assets over $11.58 million if they don’t want the assets taxed; for married couples, it’s $23.56 million. 

How does a tax bypass trust work? 

The fundamental benefit of an A/B trust is the elimination of assets from the grantor’s taxables and hence reduce their estate’s tax obligation. When a wife or husband passes away, their estate is broken into trust “A” and trust “B”; these trusts are distinct from each other. 

Trust A is marital trust. It’s of the revocable type for the surviving spouse to use as they wish. On the contrary, trust B is an irrevocable trust; it’s the family trust for the couple beneficiaries. The surviving spouse still retains access to its income, but they can’t give away, sell or spend its assets. 

Since the family trust is irrevocable, the surviving spouse does not own the assets directly, and when they die, the assets will not be counted as part of their estate, meaning the children will not face any taxes. Our suggestion, however, is to speak to one of our estate attorneys to ensure current tax codes. 

It’s possible to maintain a legacy value close to or below the $11.58 million ceilings by separating your estates into two separate trusts such as this so that your descendants avoid owing millions of dollars in tax estate.

Benefits of a bypass trust

 Couples usually create a bypass trust for the following purposes:

  • To avoid wasting estate tax exemptions: this is a legal way to reduce your descendant’s estate tax obligation or help them avoid it altogether; why not make the most of it?
  • To avoid probate 
  • To pay creditors and issue assets to heirs.
  • To ensure that if the surviving spouse decides to marry or follow a different estate plan for properties in the A trust, those in the B trust are disposed of according to the deceased’s desires.

Bypass trust distribution rules?

A bypass trust receives assets as stipulated in the trust document. These may be half or all of the property belonging to the deceased spouse; it may also just receive sufficient property to the extent that the dead spouse’s tax exclusion is fully utilized. Each trust should be written in complete detail as the specific text to be used stipulated by the IRS. 

Assets in the A trust could include cash, house, investment, life insurance policies, businesses, valuable art, antiques, and gems. Consult an estate attorney.

Bypass trust drawbacks and other options 

Creating a bypass trust can be time-consuming and costly. In most cases, an estate planning attorney who deals exclusively in this sort of trust is required. If you don’t have a significant estate, it may not be worth it. 

Bypass trusts are heavy maintenance too. The surviving partner manages the assets in the trust and keeps track of how the trust is spent. If the spouse is in their old age, they can appoint another person to act as trustee on their behalf, but this also adds to the overall cost as the trustee will have to be paid. There’s also a restriction on how much the surviving spouse can withdraw, and depending on where you live, state taxes may apply to the trust.

There is another estate planning strategy like portability to minimize administration costs and tax advantages. Consult with an estate attorney whether bypass trust is the right fit for your situation.

Other Factors to Consider

Higher appreciating assets should go in the B trust because they’ll be valued from the date of the first spouse’s death but won’t be taxed until the second spouse passes. The logic here is that they will continue to appreciate the asset. 

Finally, the trustee must determine the fair market value of the assets in trust as of the first spouse’s death date. Given the shifting value of stocks, real estate, funds, and other properties, this can be a hassle.

 Wrap-up

 Are you interested in a bypass trust? An estate attorney can help you maximize your tax exemption. Indeed, we are estate attorneys in California with experience in this sort of trust. Be it setting it up, figuring out the asset distribution, or trust management, we can help you out. Call today to speak to an expert.

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How A Bypass Trust Works | Taxation And More!

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