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Bypass Trust
When an estate is large enough (or nearly large enough) to generate estate taxes at death or if the estate is likely to appreciate significantly over time, there should be a structure built into the estate documents that ensures that each spouse can take advantage of the maximum exemption allowed from federal estate taxes. This is accomplished through a bypass trust which allows married couples to double the amount that will pass to heirs, tax-free.
To illustrate the benefit of the bypass trust, let's assume a $1 million exemption and an estate large enough to fully utilize the bypass trust at the death of the first spouse. Property is simply transferred to the trust equal to the amount offset by the federal estate tax credit ($1 million in 2011). The surviving spouse would be permitted to receive all or any portion of the income produced by the trust. In addition, the trustee would have the power to invade the corpus of the trust (withdraw principal), should this be required to maintain the standard of living of the surviving spouse. At the death of the second spouse, all trust assets would pass to beneficiaries free from estate tax, as they are not a part of the surviving spouse's estate. Further, the estate of the surviving spouse would be entitled to its own estate tax credit, enabling $1 million to be distributed to heirs free of estate tax. Hence, by utilizing a bypass trust, both marriage partners can take advantage of the federal estate tax exemption of $1 million. By doing so, couples can protect $2 million from estate taxes in (assuming a $1 million exemption amount).
The bypass trust can be very useful even for estates that are not large enough to cause them to be subject to federal estate tax. The bypass trust is perfect for the protection of assets from claims of creditors or a subsequent spouse of the survivor. Any assets transferred to the bypass trust are exempt from all claims of creditors of the survivor. Likewise, a subsequent spouse of the survivor has no right to make a claim against any of the assets of the bypass trust upon the death of the survivor or in a divorce. The bypass trust provides income to the survivor throughout his/her life, and can never be taken away from the survivor by any creditor or a subsequent spouse.
Information on this site is NOT intended for legal advice. See Disclaimer.