Do I Need a Bypass Trust?

A Practical Guide to Taxes, Control, and Better Alternatives

When clients ask whether they need a bypass trust, the first step is to clarify the concern they are trying to address. There are two very different issues:

Am I worried about estate taxes?
Or am I worried about making sure my spouse does not change the plan after I pass away?

These are very different issues, and they call for very different solutions.

1. If the Concern is Estate Taxes

For most families, it is possible to preserve the full combined estate tax exemption — currently around $30 million per couple — without using a bypass trust.

There are two main approaches:

Bypass Trust

At the first spouse’s death, a bypass trust is funded with the deceased spouse’s exemption amount. Those assets are excluded from the surviving spouse’s estate.

The tradeoff is significant:

The assets do not receive a second step-up in basis at the surviving spouse’s death.
This can result in large capital-gains taxes when the children later sell the assets.
Administration is more complex and restrictive.

Portability (Form 706)

Instead of funding a bypass trust, the surviving spouse can file Form 706 to claim the deceased spouse’s unused exemption (called DSUE).

With portability:

The survivor keeps both their own exemption and the DSUE.
The assets remain in the survivor’s estate.
At the survivor’s death, the assets receive a second step-up in basis, eliminating capital gains.
Trust administration is simpler.

Bottom line on taxes:
Both bypass trusts and portability preserve the full exemption.
The key difference is that bypass trusts lose the second step-up in basis, while portability preserves it. For most families, portability is the better tax result.

2. If the Concern is Control

Some clients are less worried about estate taxes and more focused on making sure their children actually inherit their share.

The Weakness of Many Bypass Trusts

In many traditional designs:

The surviving spouse chooses which assets fund the bypass trust.
Attorneys often recommend funding it with cash to avoid capital-gains issues.
Cash is also the asset most likely to be spent during life.

The result is that little may be left for the children.

A Better Approach: Inheritance Agreements

Our trusts allow for an Inheritance Agreement that locks in specific, traceable assets, such as:

A residence
A brokerage account
Other identifiable property

These assets:

Are easier to track
Are less likely to be spent during life
Still qualify for a step-up in basis at the survivor’s death

We also include assets of last resort language, making clear that:

The surviving spouse must spend their other assets first
Before using assets intended to pass to the children or other beneficiaries

Bottom line on control:
If your main goal is protecting your children’s inheritance, a carefully designed spousal restriction trust works better than a bypass trust.

What About a QTIP Election?

Some clients ask:

“My last attorney said I could take a QTIP election and still get a step-up for capital gains.”

That is true.

A QTIP trust requires that all income go to the surviving spouse for life. The assets are then included in the survivor’s estate, which means they get a step-up in basis.
Some trusts are drafted to let the executor choose: treat it as a bypass trust (excluded from the estate), or elect QTIP treatment (included, with step-up).

Bottom line: A QTIP election adds flexibility, but it doesn’t double your exemption (that’s done through portability).

Why Our Spousal Restriction Trust is Better

Our design improves on both the bypass and QTIP models:

All assets pass to the surviving spouse, but the spouse cannot change the beneficiaries.
Because the assets are counted in the survivor’s estate, they qualify for the second step-up in basis at death
At the same time, the survivor can file Form 706 to elect portability and preserve the deceased spouse’s unused exemption. This effectively doubles the couple’s exemption without needing a bypass trust.

We recommend choosing traceable assets (like a home or brokerage account) for restriction, since they are less likely to be spent during life, making it much more likely the children inherit them intact.

Bottom line: This approach secures your children’s inheritance, preserves the step-up in basis, and allows you to capture both spouses’ estate tax exemptions in the simplest way.

Example: Why the Second Step-Up in Basis Matters

Imagine a couple owns a house worth $2,000,000 when the first spouse dies. Their original purchase price was $500,000.

At the first spouse’s death, the basis is “stepped up” to $2,000,000.

Ten years later, the house has grown to $3,500,000.

If the house is in a Bypass Trust:

Basis stays frozen at $2,000,000.
When the children inherit and sell for $3,500,000, they face tax on the $1,500,000 gain.
At combined federal and California rates (~39%), that’s about $585,000 in tax.

If the house is in a Portability/Spousal Restriction Trust:

At the survivor’s death, the basis resets again (second step-up) to $3,500,000.
Children inherit with no taxable gain.
If sold immediately, no capital-gains tax is due.

Final Takeaway

Bypass trusts and portability both preserve the estate tax exemption. But bypass trusts come at a cost — no second step-up in basis, and often less protection for children.

Our spousal restriction trust format combines the best of both worlds:

Double the exemption (through portability),
Full basis step-up,
Locked-in inheritance for your beneficiaries.

In real terms, this can mean saving your heirs hundreds of thousands of dollars in unnecessary tax

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