If you are in the process of planning your estate with your spouse, a bypass trust may be an excellent option for you. The purpose of the bypass trust is simple: It guarantees that your estate, if left to each other, will only be taxed once. For example, if a man and a woman have a bypass trust, the estate will be taxed only when the first spouse passes away. As you can see, this type of trust can be useful, especially to those with large estates.
In order to remaining on the up and up with the IRS, and to ensure that the estate will not be taxed a second time when the remaining spouse passes, there are a number of rules that must be followed.
1. The remaining spouse must have limited access to the trust for the remainder of his life. In short, the remaining spouse does not have unlimited access to the principal of the trust. He or she cannot withdraw as much as he or she wants whenever they want. Instead, the bypass trust is designed to provide funds for health, maintenance, education and support as well as the ability to withdraw $5,000 or 5% of the principle, whichever is greater, each year. Please note that because the remaining spouse can be named as trustee of the bypass trust, this law is actually somewhat flexible.
2. The remaining spouse has a limited ability to distribute the assets of the trust at the time of their death. The remaining spouse cannot simply leave the remaining assets of the trust to his own estate, his own creditors or his estates creditors. The bypass trust can be set-up to permit the remaining spouse to designate a person, or people, to succeed the trust upon their demise. For example, the bypass trust may state that the remaining spouse may divide the remaining assets among their children. Another option is to designate the final heir in the bypass document itself, leaving the remaining spouse no discretion in the matter.
If you are considering forming a bypass trust, it is critical that you work closely with a trust attorney. The language set forth by the IRS is very specific. Any deviation, no matter how slight, may result in a revocation of the rights granted by the bypass trust. In other words, if the bypass trust is not properly worded, the benefit, that the trust will not be taxable after the second spouse passes, will be revoked.
A bypass trust can be an excellent financial tool for estate planning purposes. It gives couples the ability to control their estate, even after they pass. It also prevents them from saddling future heirs with what can be very costly estate taxes. Proper planning of your estate may very well include a bypass trust. Consult your attorney to determine if this is the best tool for you, your spouse and your joint estate.