The bypass trust is less popular today than it has been in the past. This is thanks to the increased gift and estate tax exemption ($12.06 for 2022 and $12.92 million for 2023 ) and a "portability" provision first made available in 2010. However, it remains a good estate planning option for wealthier families and, in fact, may enjoy a resurgence in future years. Here's why.
As its name implies, a bypass trust (sometimes called a credit shelter trust) is designed to allow assets to bypass your spouse's estate before others, typically children and grandchildren, inherit the property. Because the trust effectively uses the full estate tax exemption for each spouse, it may enable a married couple to transfer millions of dollars without paying any federal estate tax.
In this scenario, each spouse includes a provision in his or her will establishing a trust for the surviving spouse's benefit and funds it with the equivalent of the deceased spouse's basic exemption amount. Then, when the surviving spouse dies, the remaining assets go to the designated beneficiaries. If the trust is structured properly, this arrangement may avoid estate tax by using the estate tax exemptions of both spouses.
But here's the rub: the gift and estate tax exemption amount has been significantly boosted since near the turn of the century when it was only $675,000. After a few gradual increases, the Tax Cuts and Jobs Act temporarily raised it to $10 million (indexed annually for inflation), for 2018 through 2025. Currently, the exemption is scheduled to revert to $5 million (also adjusted for inflation) in 2026 — unless Congress takes action.
Another factor has curtailed the estate tax benefits of a bypass trust: the portability provision initially created in the Tax Relief Act of 2010 and subsequently made permanent. Under this provision, any portion of an exemption not used by the first spouse to die becomes available to the surviving spouse's estate. In other words, a couple now can transfer double the exemption amount — without estate taxes — no matter who the nonspouse beneficiaries are.
There are still several potential reasons that you may want to include a bypass trust in your overall estate plan:
Although the current gift and estate tax exemption is high at $12.06 million (increasing to $12.92 million in 2023), it's scheduled to revert to $5 million in 2026 (indexed for inflation). Depending on your family's estate planning needs, the exemption now or in 2026 may not be sufficient. Contact us to discuss the possibility of using a bypass trust or other estate planning solutions.
Get in touch today and find out how we can help you meet your objectives.