Do I Need a Bypass Trust?

When clients ask about bypass trusts (also called AB trusts, credit shelter trusts, or family trusts), we start with two core questions:

1. Is the concern estate taxes?
2. Is the concern control — making sure your share of assets goes where you intended?

The answer to these questions matters, because a bypass trust is often the wrong tool — or at least not the best one — for either goal.

1. If the Concern Is Estate Taxes

For most married couples, a bypass trust is no longer necessary for estate tax planning. Here's why.

When the first spouse dies, the surviving spouse can elect portability by filing an estate tax return (Form 706) with the IRS. Portability allows the surviving spouse to inherit the deceased spouse's unused federal estate tax exemption — currently over $13 million per person.

That means a married couple can shelter over $26 million from estate tax without using a bypass trust at all.

A bypass trust used to be the only way to preserve both exemptions. But since portability became available in 2011, most couples no longer need a bypass trust for this purpose.

Important: The Form 706 must be filed after the first spouse's death, even if no estate tax is owed. Many families miss this step — and lose the exemption entirely. We help our clients understand this requirement and plan for it.

2. If the Concern Is Control

Some clients want a bypass trust not for taxes, but to make sure assets go to their children — especially in blended families or second marriages.

The idea is: when the first spouse dies, their share goes into a bypass trust that the surviving spouse can use during their lifetime, but that ultimately passes to the deceased spouse's chosen beneficiaries (usually their children).

The Weakness of Bypass Trusts for Control

A traditional bypass trust gives the surviving spouse access to the funds — including, in many cases, the ability to withdraw principal for their health, education, maintenance, and support. That's a broad standard, and it can be interpreted loosely. The surviving spouse may drain the trust over time, leaving very little for the children it was meant to protect.

Inheritance Agreements: A Better Approach

We use a different tool called an inheritance agreement. This is a binding agreement between spouses that locks in what happens to each spouse's share — without requiring a bypass trust.

• The surviving spouse keeps full control of the assets during their lifetime
• But they cannot change the ultimate beneficiaries of the deceased spouse's share
• The assets stay in one trust — no separate trust administration required
• It's simpler, cheaper, and more protective than a bypass trust

What About a QTIP Election?

A QTIP (Qualified Terminable Interest Property) election is another approach sometimes used in second marriages. It allows the surviving spouse to benefit from the deceased spouse's assets during their lifetime, while preserving the remainder for the deceased spouse's chosen beneficiaries.

A QTIP can work, but it creates many of the same problems as a bypass trust — including the need to split assets, file a separate trust tax return, and manage two trusts. In most cases, an inheritance agreement accomplishes the same goal with less cost and complexity.

Why Our Inheritance Agreement Design Is Better

• No trust splitting required — Assets stay together in one trust after the first death
• No separate tax return — A bypass trust requires its own annual tax filing (Form 1041); an inheritance agreement does not
• Full step-up in basis at the second death — This is the most important tax advantage. Assets in a bypass trust do not get a second step-up in basis when the surviving spouse dies. That means capital gains taxes can be enormous when the children sell inherited property.
• Stronger protection — The surviving spouse cannot change the beneficiaries of the deceased spouse's share, and there is no principal invasion standard to exploit
• Lower cost — No separate trust administration, no additional tax filings, and no split-funding logistics

Example: Why the Second Step-Up Matters

Suppose a couple owns a home worth $2 million at the time of the first spouse's death. The home is placed into a bypass trust.

Ten years later, when the surviving spouse passes away, the home is worth $3.5 million.

• With a bypass trust: The cost basis is frozen at $2 million (the value at the first death). When the children sell the home, they owe capital gains tax on $1.5 million in gains. At combined federal and California rates, that could mean roughly $585,000 in taxes.
• With portability and an inheritance agreement: The home receives a full step-up in basis to $3.5 million at the second death. The children sell and owe$0 in capital gains tax.

That is a $585,000 difference — and it's a direct consequence of using a bypass trust when portability and an inheritance agreement would have done the job better.

Final Takeaway

A bypass trust is rarely the right answer. For estate taxes, portability does the same job without the complexity. For control, an inheritance agreement provides stronger protection with fewer downsides.

If you've been told you need a bypass trust, we'd encourage you to ask why — and whether the goal can be achieved with a simpler, more tax-efficient structure. That's exactly the kind of conversation we have with every client.