Bypass Trusts Law and Legal Definition
A bypass trust allows a married couple, in certain cases, to shelter more of their estate from estate taxes. The first spouse to die can leave assets in a trust which can provide income to the surviving spouse for the rest of his or her life, taking advantage of the unified credit provided under Federal Gift and Estate Tax law. Upon the death of the second spouse, the assets in the trust pass directly to the children or other beneficiaries, without being taxed at the second spouse's death.
The amount that can be left in the bypass trust increases according to the estate tax law. In 2003, as in 2002, the tax exemption is $1 million. This figure climbs to $1.5 million in 2004 and on up to $3.5 million in 2009. In 2011 the exemption returns to the 2001 tax rate of 55 percent with a $1 million exemption. A bypass trust is often called a "credit shelter" trust.
The terms of the bypass trust result in it being potentially subject to tax in the estate of the first spouse to die. However, the terms of the will or living trust that create the bypass trust limit the dollar value of the assets passing into the trust to the maximum amount is exempt from federal estate tax. Although those assets were potentially taxable, the unified credit "wipes out" the tax. The rest of the estate passes tax-free to the surviving spouse where it receives the benefit of the marital deduction.