Bypass trust
Encyclopedia
In the United States
, a bypass trust is an irrevocable trust into which the settlor
deposits assets
and which is designed to pay trust income and principal to an individual's spouse for the duration of their life. The bypass trust is not part of the settlor's and is not subject to federal estate taxes upon his or her death.
Bypass trusts are used in the United States as a legitimate tool to circumvent gift tax
, and to minimize taxation of assets upon death of a married couple. The term may have different meanings in other jurisdiction
s.
Trust A holds property that remains accessible to the surviving spouse during his or her life. That way the surviving spouse has enough wealth at hand to provide for his or her needs until death.
Trust B receives the other portion of the original trust's property in a manner that minimizes taxation, which necessarily prevents it from being accessible to the surviving spouse during his or her life. This trust is meant to pass on property to heirs
, usually the spouse's children, on death of the remaining spouse, but in a way that minimizes the estate tax and gift tax that would have been applied to the property if it had passed through a will
, or if given as a gift during life (gift inter vivos
). This Trust B takes advantage of such features as Step-Up in Basis (where the value of the property transferred to the successors of the Trust is said to be the fair market value at the time of the transfer at death, and not what the Parents originally paid for it. This means less capital gains tax
will have to be paid by the children when they sell the property).
A bypass trust receives property as specified in the trust document - the bypass trust may receive all of the property of the decedent spouse, or half of the spouses' co-owned property, or it may receive enough property to make full use of the decedent's estate tax exclusion.
It is important that each trust is drafted with absolute precision as the IRS
has specified the exact wording to be used.
The bypass trust is typically created to achieve one or more of the following goals:
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, a bypass trust is an irrevocable trust into which the settlor
Settlor
In law a settlor is a person who settles property on trust law for the benefit of beneficiaries. In some legal systems, a settlor is also referred to as a trustor, or occasionally, a grantor or donor. Where the trust is a testamentary trust, the settlor is usually referred to as the testator...
deposits assets
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
and which is designed to pay trust income and principal to an individual's spouse for the duration of their life. The bypass trust is not part of the settlor's and is not subject to federal estate taxes upon his or her death.
Bypass trusts are used in the United States as a legitimate tool to circumvent gift tax
Gift tax
A gift tax is a tax imposed on the gratuitous transfer of ownership of property. The United States Internal Revenue Service says a gift is "Any transfer to an individual, either directly or indirectly, where full consideration is not received in return."When a taxable gift in the form of cash,...
, and to minimize taxation of assets upon death of a married couple. The term may have different meanings in other jurisdiction
Jurisdiction
Jurisdiction is the practical authority granted to a formally constituted legal body or to a political leader to deal with and make pronouncements on legal matters and, by implication, to administer justice within a defined area of responsibility...
s.
In the United States
A bypass trust is a long-term planning device. It is typically created as part of an A/B Living trust estate plan after the death of the first spouse to die. During life, a married couple transfers ownership of property into a trust. Upon the death of the first party to die, the terms of the trust require that some portion of the property be transferred into "TRUST A" and some other portion into "TRUST B."Trust A holds property that remains accessible to the surviving spouse during his or her life. That way the surviving spouse has enough wealth at hand to provide for his or her needs until death.
Trust B receives the other portion of the original trust's property in a manner that minimizes taxation, which necessarily prevents it from being accessible to the surviving spouse during his or her life. This trust is meant to pass on property to heirs
Inheritance
Inheritance is the practice of passing on property, titles, debts, rights and obligations upon the death of an individual. It has long played an important role in human societies...
, usually the spouse's children, on death of the remaining spouse, but in a way that minimizes the estate tax and gift tax that would have been applied to the property if it had passed through a will
Will (law)
A will or testament is a legal declaration by which a person, the testator, names one or more persons to manage his/her estate and provides for the transfer of his/her property at death...
, or if given as a gift during life (gift inter vivos
Inter vivos
Inter vivos is a legal term referring to a transfer or gift made during one's lifetime, as opposed to a testamentary transfer ....
). This Trust B takes advantage of such features as Step-Up in Basis (where the value of the property transferred to the successors of the Trust is said to be the fair market value at the time of the transfer at death, and not what the Parents originally paid for it. This means less capital gains tax
Capital gains tax
A capital gains tax is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property...
will have to be paid by the children when they sell the property).
A bypass trust receives property as specified in the trust document - the bypass trust may receive all of the property of the decedent spouse, or half of the spouses' co-owned property, or it may receive enough property to make full use of the decedent's estate tax exclusion.
It is important that each trust is drafted with absolute precision as the IRS
Internal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
has specified the exact wording to be used.
The bypass trust is typically created to achieve one or more of the following goals:
- To maximize the use of the decedent's estate tax exclusion amount, in order to minimize estate tax upon the death of the surviving spouse
- To ensure that the decedent's spouse's property will be disposed of in accordance with the decedent's wishes, even if the surviving spouse remarries or chooses to adopt a different estate plan for the surviving spouse's assets.