Bypass Trust
A bypass trust (also called credit-shelter trust or B trust) is an irrevocable trust funded at the first spouse's death with assets equal to the deceased's federal estate-tax exemption. The surviving spouse may receive income (and limited principal under HEMS) for life, but the trust assets are NOT included in the survivor's estate — preserving the deceased's exemption for the next generation along with any growth on the trust assets.
Bypass trusts are the classic A-B trust split: at the first death, assets equal to the deceased's federal exemption fund the bypass (B) trust, and the remainder funds either an outright marital share or a QTIP (A) trust qualifying for the marital deduction. The B trust shelters the deceased's exemption permanently — neither the trust assets nor their growth are in the survivor's estate at the second death.
The portability era (post-2011) made bypass trusts optional rather than essential for federal estate-tax purposes. A surviving spouse can now inherit the deceased's unused exemption (DSUE) directly, eliminating the use-it-or-lose-it problem that originally drove bypass adoption. But two situations still favor bypass: (1) state-level estate tax in the 12+ states with separate state estate taxes (most without portability) — bypass remains the only mechanism to preserve state exemption; (2) growth expectations — DSUE is fixed at the first-death amount with no inflation indexing, while a bypass trust captures all growth outside the survivor's estate. For couples with $20M+ combined estates and meaningful growth runway, bypass trusts often beat portability mathematically.
The HEMS (Health, Education, Maintenance, Support) distribution standard is the standard for survivor access. Trustees can distribute income and principal to the surviving spouse for HEMS purposes, but the spouse cannot demand distributions or compel investment in income-producing assets. The HEMS limitation is what keeps the trust assets outside the survivor's estate — full beneficial ownership would trigger inclusion.
After the surviving spouse's death, bypass trust assets distribute per the deceased's chosen plan — usually to children or grandchildren (often through continuation trusts to leverage the GST exemption). The deceased thus controls the eventual disposition; the surviving spouse's intervening years are just income beneficiary, not full owner. This control feature is part of why bypass trusts persist in second-marriage and high-net-worth contexts even when portability would suffice federally.
| Bypass trust | DSUE / Portability | |
|---|---|---|
| First-death effort | Funded immediately, irrevocable | Form 706 election only |
| State estate tax | Preserves state exemption | Generally fails (no state portability) |
| Growth captured | Outside survivor's estate | Limited — DSUE fixed at first-death amount |
| Inflation indexing | Trust assets grow naturally | DSUE is NOT indexed |
| GST preservation | Standard mechanism | GST is NOT portable |
| Complexity | High (trust structure, trustee, accounting) | Low (one-time election) |
Synthetic widowed UHNW households should include bypass trusts when the deceased's estate exceeded the state-level exemption or when meaningful growth has occurred since the first death. Trust accounting needs to distinguish the bypass trust's assets (separate ledger, separate beneficiaries) from the survivor's own assets and from any QTIP marital trust. State-level estate-tax projection should treat the bypass trust as outside the state estate.
Common pitfalls
- Treating bypass trusts as obsolete after portability — they remain essential in state-estate-tax states and for growth-capture in large estates.
- Letting the surviving spouse exercise too much trustee control — full discretion to distribute principal can trigger inclusion in the survivor's estate.
- Failing to fund the bypass trust at first death — without timely funding, the deceased's exemption defaults to portability or is lost.
- Forgetting to allocate GST exemption to a bypass trust intended for grandchildren — GST is NOT portable; bypass-trust funding is the standard preservation mechanism.
Examples
Couple with $30M combined estate dies in CT (state exemption $13.99M, federal $13.99M). Husband dies first. Plan: $13.99M to bypass trust (funded to deceased's exemption); $13.99M qualifies for marital deduction (passes outright or QTIP); zero remaining. Husband's federal exemption used in bypass; CT exemption also used (no state portability). Wife's estate at death: $16M (her own + accumulated) − $13.99M wife's federal exemption = ~$2M federal taxable, $800k federal tax. Bypass trust grows to $20M during widow's life; distributes to children gift-and-estate-tax-free at her death.