For income tax savings, don’t bypass basis – Lexology


Traditionally, due to lower estate tax exemption amounts, many married couples would use bypass trusts or credit shelter trusts as part of a typical estate plan. For example, on the death of the first spouse, assets in that spouse’s revocable trust would be allocated to a bypass trust (frequently referred to in the trust document as a family trust) up to the amount of the deceased spouse’s remaining estate tax exemption, with the balance allocated to a marital trust for the surviving spouse. The bypass trust would not only pass estate tax free at the first spouse’s death, but would also be outside of (i.e., bypass) the surviving spouse’s taxable estate at death. In addition, the bypass trust assets might continue from generation to generation without being subject to any additional “transfer taxes” like the generation-skipping transfer (GST) tax, if GST exemption was allocated to the trust. This type of planning continues to provide a variety of benefits.

With the passage of the 2017 Tax Act, the estate tax exemption amount has increased from $5,490,000 per individual in 2017 to $11,180,000 per individual in 2018, or $22,360,000 per married couple. This generally means that an estate tax will not be levied unless assets are in excess of these amounts. As a result, many couples are finding that their total assets are well below the current estate tax threshold. However, it is important to keep in mind that this increase in exemption is temporary due to a sunset in the Tax Act. Beginning Jan. 1, 2026, the exemption will fall back down to $5 million adjusted for inflation.

While bypass trusts are great for sheltering assets from the estate tax, one income tax drawback is that the assets in a bypass trust generally do not receive a “basis step-up” at the death of the surviving spouse.

For income tax savings, don’t bypass basis – Lexology

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