Definition
A bypass trust, also known as a credit shelter trust or an exemption trust, is an irrevocable trust used in estate planning to pass assets from parents to their children while minimizing or avoiding estate taxes. This type of trust is designed to take advantage of the federal estate tax exemption amount, ensuring that both spouses can use their lifetime exemptions. The assets placed in a bypass trust exceed the amount that children and other heirs can receive tax-free at a parent’s death.
The surviving spouse can benefit from the income generated by the trust during their lifetime, and in some cases, may access the principal under dire circumstances. This is allowed by utilizing two lifetime exemptions, which were $5,000,000 in 2011 but are subject to change based on current tax laws.
Examples
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Typical Bypass Trust Setup: John and Mary set up a bypass trust with $6,000,000. Upon John’s death, $5,000,000 is placed into the trust, using John’s lifetime exemption. Mary benefits from the income this trust generates but does not own the assets, preserving them for their children without estate tax implications.
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Qualified Terminable Interest Property Trust (QTIP): Another variation of a bypass trust is a QTIP, which ensures that a surviving spouse receives income from the trust for life while the principal eventually goes to the children, preserving more control over the distribution timing and terms.
Frequently Asked Questions (FAQs)
What are the benefits of a bypass trust?
- Tax Reduction: Helps minimize estate taxes.
- Protection: Provides surviving spouse with income while preserving the principal for heirs.
- Estate Exemption Utilization: Makes use of both spouses’ estate tax exemptions.
Can the terms of a bypass trust be changed?
No, bypass trusts are irrevocable, meaning the terms cannot be altered once the trust is established.
How does a bypass trust work after one spouse dies?
The trust assets move into the bypass trust, utilizing the deceased spouse’s estate tax exemption. The surviving spouse typically receives income from the trust, with the principal preserved for distribution to the children upon the surviving spouse’s death.
Does a bypass trust affect eligibility for state-specific estate taxes?
It depends on the state. Some states have separate estate or inheritance taxes, so it’s advisable to consult with a local tax advisor.
What happens if the survivor needs access to the principal of the bypass trust?
Though uncommon, certain trust terms might allow the surviving spouse to access the principal under specified circumstances, such as dire financial need.
Related Terms
Estate Tax: A tax imposed on the transfer of the deceased’s estate to their heirs.
Irrevocable Trust: A type of trust where the grantor has relinquished all control over the assets placed in the trust.
Lifetime Exemption: The maximum amount that an individual can transfer without being subject to federal estate tax.
Qualified Terminable Interest Property Trust (QTIP): A type of trust allowing a spouse to receive income for life while preserving principal for other beneficiaries.
Online Resources
- Investopedia: Bypass Trust - Comprehensive information on how bypass trusts work.
- IRS: Estate Tax - Direct IRS resource on estate tax laws and exemptions.
- Nolo.com: Bypass Trust Basics - Detailed explanation of bypass trust fundamentals.
Suggested Books for Further Studies
- “The Essential Guide to Trusts, Estates, and Wills” by David A. Handler
- “Make Your Own Living Trust” by Denis Clifford
- “The Complete Book of Trusts” by Martin M. Shenkman
Fundamentals of Bypass Trusts: Estate Planning Basics Quiz
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