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:
Portability freezes the ported exemption amount at the first spouse’s death. If you port a $15 million exemption, and those assets appreciate to $25 million by the second death, the $10 million of growth is subject to a 40% estate tax. In contrast, if funded into a bypass trust, the entire $25 million escapes estate tax at the second death.
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.
Many states (e.g., Oregon, Washington, New York, and Massachusetts) impose state-level estate taxes with exemptions far lower than the federal limit (often $1 million to $5.49 million) and do not recognize portability. A bypass trust is required to utilize the state-level exemptions of both spouses.
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, utilizing a marital trust (Trust A) and relying on portability to secure a second step-up is the superior strategy.