Tax By-Pass Trust

Tax By-Pass Trusts are trusts that are irrevocable, meaning they can’t be changed once they are created, and the terms must be carried out.  In some cases where circumstances make carrying out the terms of the trust uneconomical or too difficult a court may step in to allow the terms to be changed, but for the most part, once the terms are set and the trust completed, everything remains as it is set up.

It is because of this reason, Tax By-Pass Trusts, as with any irrevocable trust, must be created with care and consideration and not be done carelessly.  Decisions such as beneficiaries, executors, and terms, all must be gone through carefully and thoroughly before the final paperwork is signed.

The main purpose of a Tax By-Pass Trust is to provide for a remaining spouse once the other spouse has passed away.  A Tax By-Pass Trust is a trust that both spouses created together and ownership of property they have together is put into a trust.  When one or the other spouse dies, a portion of the trust is transferred into a separate trust labeled Trust A and a portion of the trust is transferred into another trust labeled Trust B.

The part of the trust that is put into Trust B is not subject to the same taxation and is not available to the surviving spouse.  This is meant as a way to have part of the trust to pass on to heirs of the couple, typically the couple’s children.   The Tax By-Pass Trust gives the surviving spouse as well as the heirs many tax benefits that make this type of trust very desirable.

Care must be taken to adhere to all IRS regulations when setting up this trust so be sure that the person setting up the trust is very knowledgeable in this type of process.  It will avoid many headaches later.  This trust is a long term planning trust, and is a way for the couple’s assets to be protected as well as the children of the couple’s inheritance later on.

There are certain conditions that must be in place according to rules set by the IRS for the trust to avoid estate tax when one spouse dies.

  • Limit the power of the surviving spouse to access the trust during their lifetime
  • Limit the power of the surviving spouse to distribute trust assets upon their death

The surviving spouse can be given the power to decide who the remaining assets go to upon their death but can’t give any of the assets to themselves or their own estate.  You can also put stipulations in the trust that state where it goes upon their death and the trust distribution would have to follow those terms.

There are also specific words that need to be in place in the By-Pass trust, so make sure the attorney who draws up the trust is very knowledgeable in Federal Tax laws.  An error in this step could cost you hundreds of thousands of dollars.

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