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A Bypass Trust (also called a Credit Shelter Trust, Exemption Trust, or, in come cases, a "Family Trust") is used for married couples who have a net worth greater than the amount which is exempt from estate taxes ($2,000,000 in 2008).

A Bypass Trust permits a couple to pass the maximum amount of property to their children or other beneficiaries after both spouses die, while at the same time ensuring the surviving spouse is financially comfortable. It's one of the few times in life you really can have it both ways.

A Bypass Trust works as follows: Instead of leaving property outright to the survivor, each spouse leaves an amount of property to a By Pass trust. Let's say the husband leaves assets worth $2,000,000 a Bypass Trust for the benefit of his wife. The surviving spouse can use that property, with certain restrictions, but doesn't own it outright. That's the reason behind the big tax savings: the property isn't subject to estate tax when the second spouse dies, because the second spouse never legally owned it.

He leaves the rest of his estate to his wife tax free because there is no tax on what one spouse leaves to another spouse.

When setting up a marital life estate trust, each spouse names final beneficiaries who will receive the trust's property when the surviving spouse dies. Spouses often name the same people--the couple's children--as final beneficiaries, but it's not mandatory.

When the wife dies, she can leave $2,000,000 to the children without tax. The assets in the trust also pass to the children tax free. (Those assets belonged to the trust - not to her.) The effect is that $4,000,000 passes to the children with no estate tax.

A bypass trust can be set up as a living trust or in a Will as a testamentary trust. It can be revocable or irrevocable.

For more information, see:

The Surviving Spouse's Rights

If the surviving spouse is trustee, he or she can have limited power over the assets in the Bypass Trust. The extent of this power depends on the terms of the trust, within limits set by the IRS. If a Trustee surviving spouse is given more power than IRS rules allow, the surviving spouse becomes the legal owner of the trust property -- the exact opposite of what was intended.

The surviving spouse may:

  • Receive all interest or other income from the trust property.
  • Use the property--for example, she can live in a house owned by the trust.
  • Spend the trust property in any amount for his or her health, education, support and maintenance, in his or her accustomed manner of living.

If the surviving spouse is not the trustee of the bypass trust, then distributions may be made for any purpose by whoever (or whatever) is trustee to the surviving spouse as beneficiary.

After the death of the surviving spouse, the marital life estate trust property is distributed to the final beneficiaries, chosen by the deceased spouse in the original trust document.

The surviving spouse's property is also distributed to her beneficiaries.

The Downside Of A Bypass Trust

Possible disadvantages of a Bypass Trust include:

  • Restrictions on the surviving spouse's use of the property.
  • Expense of legal or accounting help setting up the trust and keeping it going.
  • Recordkeeping. There must be a separate set of records for the trust.
  • Preparing trust tax returns. An annual income tax return has to be filed for the trust.
  • There may be a conflict between the needs of the surviving spouse and the beneficiaries who take the assets when the spouse dies.

Edited by:
Jerry Simon Chasen, Esq.
Chasen & Associates, P.A.
Miami, Florida

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