The term bypass trust refers to an estate planning tool that allows the donor to provide assets to survivors while avoiding estate taxes. Bypass trusts are frequently used by parents to pass assets to their surviving spouse and children.
Also referred to as a B-trust, a bypass trust is an estate planning tool that can help families lower, or eliminate, estate taxes. Typically used by married couples with children, each spouse will first direct their solely-owned assets into this trust upon their death. These assets might include life insurance policies, retirement accounts such as a 401(k) or 403(b) plan, or any other revocable trust that names the bypass trust as the beneficiary.
The bypass trust can then be used to provide the surviving spouse with a source of lifetime income. Under certain conditions, the trustee may have the power to distribute the trust's corpus too. The trust's donor must provide specific instructions on how much corpus can be distributed and under what conditions. If the bypass trust is constructed properly, the assets remaining after the death of the surviving spouse would not be included in their estate, and would be passed to the beneficiaries of the trust on a tax-free basis.
Since the Internal Revenue Services (IRS) will not honor an improperly prepared bypass trust, they are typically prepared by an attorney that specializes in estate planning.