Understanding a Bypass Trust

A bypass trust, also known as a "B" trust or credit shelter trust, can be set up as a living trust or as a testamentary trust. The most common method is to set it up as a testamentary trust. The idea is to include the estate tax exemption amount in the trust that way as the grantor dies the surviving spouse will receive the remainder of the estate, not have to pay estate taxes, where the remainder is deductible using the marital deduction rule. The surviving spouse will still receive the benefits of the trust. This way the survivor bypasses all estate tax liability. In 2009 the estate tax exemption is $3.5 million.

Another way to make use of the "B" trust is to make it a living trust. This way it passes to heirs using the lifetime gift tax credit allowing up to $1 million in exemption. All future appreciation of property transferred into the living trust is free from estate tax once transferred. You must file form 709 if making this gifting transfer.