Bypass Trusts
A bypass trust—also known as a credit shelter trust (CST), B-trust, or family trust—is an irrevocable trust designed to utilize the estate tax exemption of the first spouse to die, sheltering both the initial principal and all future appreciation from estate taxes at the surviving spouse’s subsequent death.
Historically, before federal exemption portability was enacted, married couples used the standard A/B trust structure to avoid wasting one spouse’s exemption. Upon the first death, the living trust split into a survivor’s trust (Trust A, revocable, holding the survivor’s share) and a bypass trust (Trust B, irrevocable, funded with the decedent’s assets up to their available exclusion amount under IRC §2010). The surviving spouse can receive all income from the bypass trust and access principal under a HEMS standard, but because they do not control the trust, the assets bypass their taxable estate.
The introduction of the Deceased Spousal Unused Exclusion (DSUE), or portability, allows the surviving spouse to inherit the decedent’s unused exemption, prompting some to view the bypass trust as obsolete. However, relying solely on portability exposes your estate to significant risks:
- Appreciation Capture
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Portability freezes the ported exemption at its dollar amount on the first death; a bypass trust freezes nothing, because the assets themselves are outside the survivor’s estate. The cost of choosing portability is therefore the tax on the growth:
for an amount sheltered, growing at over the years between the two deaths. Port a $15 million exemption against assets that reach $25 million by the second death and the $10 million of growth is taxed at 40%—$4 million. Fund the same $15 million into a bypass trust and the entire $25 million passes untaxed. At 5% growth over fifteen years the gap is larger still: $15 million becomes $31.2 million, and $16.2 million of growth carries $6.5 million of avoidable tax.
- Remarriage Risk
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Under the “last deceased spouse” rule ( Treas. Reg. §20.2010-3(a)(3)), if the surviving spouse remarries and the new spouse dies, the surviving spouse loses the unused exemption from the first deceased spouse. A bypass trust protects the exemption from being lost due to remarriage.
- State-Level Estate Taxes
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Roughly a dozen states impose their own estate tax at exemptions far below the federal limit, and—critically—none of them recognize portability. For 2026: Oregon at $1 million, Massachusetts at $2 million, Illinois at $4 million, Minnesota at $3 million, New York at about $7.35 million with a brutal “cliff” that taxes the estate from the first dollar once it exceeds 105% of the exemption, and Connecticut alone matching the federal $15 million. Washington is the cautionary tale in how fast this moves: ESSB 5813 (2025) raised the exclusion to $3 million and the top rate to 35%, then ESB 6347 (2026) rolled the rate back to 20% for deaths on or after July 1, 2026 — so 2026 is a split year in which the date of death changes both the exclusion and the rate table. If you live in any of these states, a bypass trust is the only way to use both spouses’ state exemptions, and the federal step-up analysis below is not the whole calculation.
- Control and Creditor Protection
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A bypass trust guarantees that the remaining assets will eventually pass to your children or designated heirs, preventing the surviving spouse from diverting wealth to a new partner. The irrevocable structure also shields the corpus from the surviving spouse’s creditors.
The primary trade-off of a bypass trust is the loss of a second step-up in basis. Assets in the bypass trust are excluded from the surviving spouse’s gross estate, meaning they do not receive a second capital gains basis adjustment under IRC §1014 when the surviving spouse dies. If the assets consist of low-basis holdings with modest appreciation potential, the capital gains tax on the carryover basis may exceed the estate tax savings. In such cases, routing the assets through the marital trust (Trust C) and relying on portability to secure a second step-up is the superior strategy.