Back to: INHERITANCE, ESTATES, & TRUSTS
Bypass Trust or Credit Shelter Trust Defined
A Bypass or Credit Shelter Trust refers to a method of passing assets to beneficiaries without subjecting those assets to estate taxes. The Bypass trust is designed in such a way upon the death of the settlor or creator of the trust, the assets stated in the trust agreement and income generated from those assets are transferred to the spouse of the settler.
Besides, one of the key importance of Bypass trust is that it gives the surviving spouse some rights to the assets under trust during the remainder of her or his lifetime. In case of some circumstances such as payment for education or medication, the surviving spouse is allowed to not only the income but also the trust`s principal. On the other hand, upon the death of the surviving spouse, the assets of the trustees are transferred to the remaining beneficiaries without charging any estate tax.
A Little More on What is a Bypass Trust or Credit Shelter Trust
Credit shelter trusts are developed upon the death of a married individual and financed by the entire estate of the person or a portion of it at agreed upon in the trust agreement. These assets then transferred to the surviving spouse. However, since a chosen trustee controls trust, the trustee is obligated to take control of the asset at the expense of the spouse. As such, the transfer of the asset does not add taxable estate to the surviving spouse.
How Do Credit Shelter Trusts Offer Tax Protection?
Credit shelter trusts are created to make the couples take complete advantage of the estate tax exemptions. The tax law provides that the estate, gift, and generation-skipping transfer tax (GSTT) exemption is occurred at $10 million tax base for single individuals and $20 million tax base for married individuals until December 31, 2025 – taking into consideration that the Congress does not often update the Tax Cuts and Jobs Act until then.
Taking into consideration these figures, suppose the couples who have been in the marriage for a longtime accumulate estate worth $6 each and the husband and the husband create a credit shelter trust to be financed upon his death with his share of their combined estate. After the death of the husband, his portion worth $6 million estates and any income received from the estate is transferred to the wife at estate-tax free since it is an exemption because it falls below the federal exemption.
In this regard, the transfer boosts the net income of the wife to $12 million and past the estate-tax exemption. However, since these assets were out of her control, her taxable estate will still stand at $6 million which still fall within the tax exemption bracket. Therefore, the assets can be transferred to the children upon her death.
Credit shelter trusts are also referred to as Bypass Trusts or AB Trusts.
References for Bypass Trust
Academic Research on Bypass Trust
- New Estate Planning Techniques For Small and Medium Sized Estates, Peckham, E. E. (1982). NY St. BJ, 54, 514. This paper explores the estate planning models for the medium and small-sized estate. The author provides an in-depth discussion concerning the trust agreement and management of the estate of the deceased. The article reveals that the exemption estate tax is based on the value of the estate under the trust agreement. Similarly, the models used in estate control also depends on the size of the estate.
- Explanation for an expert system that performs estate planning, Schlobohm, D. A., & Waterman, D. A. (1987, December). In Proceedings of the 1st international conference on Artificial intelligence and law (pp. 18-27). ACM. This paper investigates and makes recommendations concerning the current estate planning and management based on the provision of the law and the international artificial conference. The investigation was based on two main areas. First, it investigates the practical use of intelligent legal information concerning estate planning and management. Secondly, the paper investigates the theoretical aspect of computational models for planning and control the estate under the law regarding the management of the estate.
- What Portability Means to Trust and Estate Professionals, Bekerman, M. S. (2009). Prob. & Prop., 23, 39. The concept of allowing the surviving spouse` estate to apply the unused estate tax exemption amount has been a matter of discussion for a long period. In this regard, this paper examines the concept of using the estate tax exemption amount by the surviving state. According to the author, this concept is referred to as “portability” herein. The concept can be used to simplify the estate plan for wealthy individuals. The article also reviews the possible impacts of portability in case it is implemented.
- Funding Bypass Trusts with Retirement Assets, Hoyt, C. R. (2004). Prob. & Prop., 18, 10. This paper attempts tom predicts the federal estate tax that is likely to occur in the Bypass trust agreement. According to the author, due to the uncertain nature of the estate tax, the couples need to be cautious about the model they use for their estate planning. The further author state that Bypass trust has considerable benefits to the couples that intend to use it. One of the benefits of Bypass trust is that it allows the married individuals to maximize the use of federal tax exemption and generate more income for the successive generation.
- Marital Deduction Estate Planning: Variations on a Classic Theme, Dobris, J. C. (1982). San Diego L. Rev., 20, 801. This article presents a detailed study of the marital deduction under the federal wealth transfer tax laws. It analyzes practical and tax advantages of using the marital deduction as well as its potential pitfalls, including issues raised in planning, qualification, funding, and administering a marital bequest.
- Marital Deduction Estate Planning after the Economic Recovery Tax Act of 1981, Katz, W. A., & Blessing, A. H. (1981). J. Mo. B., 37, 503. For a long period, many changes have occurred regarding the management and making estate plans. These changes have significantly influenced the management of estate following the continuous changes in the law. In this regard, this paper summarizes the new estate tax changes and discuss their implications. The article also emphasizes the on an equitable model in the property division among the beneficiaries rather than concentrating in exclusively maximizing estate tax.
- Portability of the Federal Estate Tax Exemption, Fee Jr, E. G. (2009). Md. BJ, 42, 34. This paper explores the portability of the federal estate tax exemption between married couples. According to the author, the portability of the federal tax comes into play if the first spouse dies and the value of the estate does not require the use of all of the deceased spouse’s federal exemption from estate taxes.
- Computing the Optimum Marital Deduction: Is a Zero-Tax Formula Appropriate?, Llewellyn, D. W., Levin, K. J., & Richmond, G. L. (1989). Real Property, Probate and Trust Journal, 331-369. This paper explores the models used in computing the optimal marital deduction. The major focus is geared towards zero-tax formula. According the author, the analysis of the optimum marital deductions often limited to a comparison of two values. The article also discusses the factors that determine optimum marital bequest and further conduct a comparative analysis on the advantages and disadvantages of the marital deduction formulas.
- The federal estate and gift tax: a case study in uncertainty, Kaufman, B. S. (2011). National Tax Journal, 64(4), 943-949. This article uses the Federal estate and gift tax to explain the uncertainties that exist in the tax law. After proving a brief description of the past circumstance regarding these taxes and recent legislation put in place, the paper the discusses two examples of the uncertainty effects on the taxes. Lastly, the paper explores the negative consequences of the uncertainties that exist ion the tax law.
- Misconceptions About Estate Planning, Feldman, R. H. (1999). Ariz. Att’y, 36, 30-31. This paper presents the misconceptions that are spread about estate planning. According to the author when an individual fails to make their own choice, they chose and utilized the choices imposed by the law. This means that not only the wishes of the individual intending to make a decision not being fulfilled but also putting the family at risk of not settling the estate.
- Funding Testamentary Trusts on the Death of the First Spouse, Zuckerman, H. L., & Soled, J. A. (1995). Experience, 6, 35. Estate planning for couples can sometimes extend beyond developing some special testamentary trust. This paper explores the funding models for the testamentary trust upon the death of the first couple. The author presents that when testamentary trust is properly structured, the estate planning can yield considerable federal estate tax savings.