A bypass trust, also known as a family trust or credit shelter trust, is a type of an irrevocable trust used to pass assets, usually from a parent to a child, when the second spouse has died and the estate is much larger than when the first spouse died.
However, if not correctly handled, a bypass trust can undo even the best estate planning.
Here’s one such scenario:
- A widow has a building in trust when her husband dies in the 1990s. The value of the building was $600,000, and over the years the building has grown in value to more than $1 million. Due to depreciation, its cost basis is about $250,000.
- If the building remains inside the bypass trust and the widow dies and the building is sold, her children will pay a capital gain of $750,000 and tax of at least $250,000 upon the sale of the property. The widow has no estate taxable estate.
- By transferring the building out of the trust to her, upon her death it will be stepped up to full market value, and there will be no tax if it is sold.
If Medicaid is an issue, the credit shelter trust can protect the assets from being spent for care. But, if your credit shelter trust does not have proper supplemental language the trust assets may be at risk. Believe it or not, there are ways to add such language and strengthen the asset protection of the trust.
If your estate plan has assets held in bypass trusts, it may be necessary to make changes to protect your children from hefty tax burdens or make sure it is not an available resource for Medicaid. Call our office at 516-307-1236 to learn how we can help.