Married couples use the bypass trust (also known as a credit shelter trust or AB trust) as an estate planning technique to prevent the loss of the federal estate tax exemption of the first spouse to pass away and thus possibly reduce the amount of estate taxes paid at the time of the passing of the second spouse.
In simple terms, it allows each couple to use their full federal estate tax exemption rather than lose it. The need for a bypass trust has been reduced by recent changes to the tax laws (i.e., portability); however, this type of trust still provides significant value to many estates, including those with higher net worths and blended family situations.
Key Takeaways
- A bypass trust is a legal tool that allows married couples to use each spouse’s federal estate tax exemption.
- Once the first spouse passes away, the bypass trust will be irrevocable.
- The assets that go into the bypass trust do not count as part of the surviving spouse’s taxable estate.
- Bypass trusts also offer additional protection against creditors and enable the couple to control how they would like their remaining assets distributed at death.
- While portability (the ability to transfer one deceased person’s unused exemption) has reduced the need for bypass trusts in many cases, it does not eliminate the need entirely.
- If the federal estate tax exemption decreases after 2026, the importance of bypass trusts could increase.
What Is a Bypass Trust?
A bypass trust is also known as an estate tax exemption trust (credit shelter) or an irrevocable trust established by the deceased spouse after one of them has passed away. The purpose of a bypass trust is to provide “bypass” relief to the survivor’s estate while providing benefits to the survivor for his/her lifetime from the assets contributed to the bypass trust.
“Bypass,” in this context, simply means that the assets in the bypass trust will be excluded from consideration when determining what belongs in the surviving spouse’s estate. Consequently, those assets may be able to avoid estate taxes upon the second spouse’s passing.
Typically, bypass trusts are utilized by married couples who have considerable amounts of wealth and/or whose estates are expected to exceed the current federal estate tax exemption.
How Does a Bypass Trust Work?
So before we dive into the specifics of what this looks like for you, let’s go back and take a look at trusts in general. If you’ve done that already, then it’s time to get familiar with how a bypass trust works. Let’s walk through it together, one step at a time.
When the first spouse dies:
An estate plan directs assets to two components (commonly referred to as an AB trust):
- Trust A = survivor’s or marital trust
- Trust B = bypass or credit shelter trust
The bypass trust will be funded with all of the deceased spouse’s assets to the extent possible under current federal estate tax exemption amounts.
The surviving spouse can potentially receive:
- Income created from the income-generating trust assets
- Limited ability to use the trust assets’ principal (dependent upon the provisions of the trust)
Once the surviving spouse dies:
- The assets contained within the bypass trust will be distributed to those individuals who were named as beneficiaries of the trust (commonly, children).
- Those assets will NOT be considered part of the taxable estate of the surviving spouse.
Below is a simplified overview:
| Event | What Happens |
| First spouse dies | The estate splits into marital trust and bypass trust |
| Funding stage | Assets equal to the exemption go into the bypass trust |
| During the survivor’s life | The surviving spouse receives income and limited distributions |
| Second death | Bypass trust assets transfer to heirs outside the taxable estate |
Historical Background: Why Bypass Trusts Were Created
Prior to the introduction of portability rules, all estate taxes had “use it or lose it” exemptions. When a person’s first spouse dies, and they do not utilize their available exemption, it is lost forever. The unlimited marital deduction provides for an asset to be passed from one spouse to another without incurring an estate tax; however, when the second spouse dies, there will be an estate tax on those same assets in his/her estate.
Bypass Trust vs Portability vs Marital Trust
One of the most common questions today is whether a bypass trust is still necessary now that portability exists. Let’s compare.
What Is Portability?
Portability has been a part of the U.S. tax code for many years. Before portability became part of our tax code, “Use It or Lose It” applied to estate tax exemptions.
If the first spouse passed away without utilizing his/her exemption, it was gone forever. Assets may have passed through an unlimited marital deduction to the survivor; however, when the second spouse passes, those assets will be taxed at that time as part of the survivor’s estate.
Comparison Table
| Feature | Bypass Trust | Portability | Marital Trust |
| Uses first spouse’s exemption | Yes | Yes | No |
| Protects asset growth from estate tax | Yes | No | No |
| Requires trust administration | Yes | No | Yes |
| Creditor protection | Often yes | No | Limited |
| Protects from remarriage risk | Yes | No | Limited |
| Automatic | Yes (if structured) | Must elect | Yes |
Key Insight: Growth Protection
Growth protection is one of the areas of comparison between bypass trusts and portability that is frequently overlooked. A major difference in the growth of an asset(s) post-inheritance is that if the deceased couple relies solely on portability, their surviving spouse will receive all inherited property as his/her own. Any increases in value to those inherited properties after receiving them (from investing, real estate, etc.) are now part of the surviving spouse’s taxable estate.
On the other hand, when a deceased couple places some or all of their assets in a bypass trust, any appreciation of those assets remains outside of the surviving spouse’s estate. Therefore, this separation may have significant benefits for families with high-growth assets (such as commercial real estate and private equity) because any additional appreciation of these assets after the estate tax exemption could result in a very large tax liability.
Bypass Trust Example
Consider a married couple that has an estate of $20 million. The federal exemption for each individual will be around $13 million.
Without a Bypass Trust
The first spouse passes away. All assets pass to the surviving spouse under the marital deduction. No taxes are owed on the first spouse’s death. At the time of the second spouse’s death, the combined value of both spouses’ estates is now $25 million. Only one exemption is available, unless the election to use portability was made. If so, there may still be a tax owed on the excess over the exemptions.
With a Bypass Trust
The first spouse uses their entire $13 million exemption immediately upon passing. That $13 million is placed into the bypass trust created by that spouse. The remaining balance of the assets will either go to the marital trust or to the spouse. Any growth within the bypass trust is excluded from being included in the decedent spouse’s final estate. At the time of the second spouse’s death, it is possible to have significantly reduced potential taxable exposures.
Even if portability had been elected, the bypass trust would protect against post-death appreciation of assets.
Advantages of a Bypass Trust
A well-structured bypass trust has many advantages:
- Increases both spouses’ use of their estate tax exemption (Maximum)
- Preserves growth in assets and protects them from future estate taxation
- May provide protection for the surviving spouse’s creditors
- May protect asset growth from risks associated with remarriage
- May help preserve inheritance rights for children of prior marriages
- May give control over how the ultimate distribution will take place
In particular, the “control” advantage of this type of trust is significant for blended family situations. The bypass trust will ensure that assets are distributed to the intended heirs.
Disadvantages and Limitations
Bypass trusts are not always needed for an estate.
- Potential downsides of bypass trusts can be:
- Greater complexity and greater administration required
- Higher legal and accounting fees
- Less flexible than direct distribution through will
- A “second-step up” in basis when the surviving spouse dies does not occur with a bypass trust.
In cases where there is a large amount of wealth but little or no potential estate tax liability (i.e., the couple’s net worth is below both the federal and the state estate tax exemptions), it may be possible to use a much simpler structure.
Estate Tax Considerations
There are many different types of state inheritance and/or estate taxes in addition to federal estate taxes. The majority of states have lower exemption thresholds than federal law, meaning bypass trusts will continue to offer planning advantages even when there is little to no federal exposure.
For example:
- The amount an individual is exempt from paying in a particular state may range from $1 million to $1-$5 million.
- A bypass trust could preserve the first spouse’s state-level exemption amount.
An estate planner should be aware of both the federal and state tax regimes.
What Happens to the Estate Tax Exemption After 2026?
The federal estate tax exemption will expire on December 31, 2025, unless Congress extends it. In that event, as of January 1, 2026, there could be a significant decrease to approximately fifty percent (50%) of the present exemption level, adjusted for inflation. The reason this is an important factor is that we see renewed interest among high-net-worth families and their advisors in creating bypass trusts, as they can protect future estate growth if either spouse passes away first.
In addition to preserving both spouses’ exemption amounts, a bypass trust can also protect an estate’s appreciation over time, create additional creditor protection, and preserve the right of inheritance in blended families.
Who Should Consider a Bypass Trust?
A bypass trust may be appropriate for:
- Couples with estates near or above the federal exemption
- Business owners with appreciating assets
- Real estate investors
- Blended families
- Families concerned about remarriage risk
- Individuals seeking asset protection layers
It may be less necessary for:
- Couples with modest estates well below the exemption
- Those prioritizing simplicity above all else
Many estate plans that have been well-designed by experienced planners will create unintended tax problems if bypass trusts are not properly funded or reviewed periodically.
Some of these common issues include:
- Outdated documents related to a prior version of the federal estate tax law;
- Reliance upon the concept of portability without consideration for the potential growth in value of your assets;
- Inadequate (or improper) funding of the bypass trust at the first spouse’s death.
- Failure to take into account the possibility of significant amounts of money being subject to state-level estate taxes;
- Not coordinating retirement plan distributions, life insurance policy beneficiaries, etc., with the terms of the bypass trust.
As such, it is sometimes necessary to review your trust documents with an attorney who specializes in estate planning every few years to ensure they reflect current legal and regulatory requirements.
Summary
A bypass trust is a method of estate planning where two spouses work together to preserve the estate tax exemption of the spouse who passes away first. This is accomplished by creating an irrevocable trust into which the deceased spouse’s assets are placed. Once these assets are in the trust, they will bypass the surviving spouse’s taxable estate. Since portability has made this process somewhat less relevant to many individuals, a bypass trust provides benefits, including protecting the future growth of assets, preserving control of inheritance, and providing protection against creditor claims should either spouse remarry.
As we move closer to the possible repeal of the increased estate tax exemptions beyond 2026, there could be additional demand for bypass trusts among high-net-worth families. Similar to other advanced strategies available to you through your estate plan, whether or not to establish a Bypass Trust will depend on your overall financial picture, including asset size, your family dynamics, your tax situation, and ultimately what goals you wish to accomplish.
Frequently Asked Questions
Is a bypass trust the same as a credit shelter trust?
Yes. The two names are interchangeable. They both describe a trust designed to take advantage of the estate tax exemption available to each spouse and to exclude those assets from the surviving spouse’s taxable estate.
Does a bypass trust avoid estate taxes completely?
No. If you have sufficient assets in excess of your applicable exclusion amount, your heirs will still pay some estate taxes. Your goal would be to reduce the total estate tax owed on all property you leave behind.
Is a bypass trust still necessary if portability exists?
Portability will meet the needs of most couples. However, portability does nothing to protect against future increases in wealth, nor will it afford you the same level of control and creditor protection as a properly drafted bypass trust.
What happens to a bypass trust when the surviving spouse dies?
Upon the death of the surviving spouse, the assets held in the trust will go directly to the beneficiaries named in the trust (usually children) under the provisions set forth in the trust document and will not be included in the surviving spouse’s taxable estate.
Can a bypass trust protect assets from creditors?
It will depend upon how well your attorney drafts your bypass trust. One of the primary functions of a bypass trust is to create a protective barrier around those assets for the benefit of your surviving spouse so that no creditors can access them.
What is the difference between a bypass trust and a marital trust?
A marital trust qualifies for the unlimited marital deduction, therefore delaying any potential estate taxes until after the death of the surviving spouse. A bypass trust utilizes both spouses’ exemptions to “bypass” each spouse’s estate, thereby avoiding inclusion in either spouse’s estate.
