What it is:
How it works/Example:
Let's say John Doe owns a horse farm worth $11 million. He wants to pass the farm down to his son, James, when he dies. He does not have much in the way of
John the farm in a bypass trust. Then he dies and James inherits the farm. James works the farm for 40 years, and then he dies and leaves the farm to his son, Jake.
Because the farm is in a bypass trust, James has to pay on the farm when he inherits it from John, but Jake does not have to pay on the farm when he inherits it from James. This is a good thing, because James has already paid estate taxes on the farm. Making Jake pay estate taxes again on the farm would amount to double taxation.
A bypass trust is irrevocable, meaning that once John the farm into a trust for James, he can't undo it. They also come with certain limits. For example, James must have restricted rights to liquidate the farm's assets, and John must specify in the trust what James can do financially in that regard. John can also control who James may leave the farm to.
Why it matters:
Bypass trusts help parents pass assets to children or other beneficiaries (or spouses pass assets to each other) in a manner that prevents the assets from being subjected to tax times. However, because they are irrevocable, the decision to assets in a bypass trust is one that must be made carefully. Also, the IRS sets forth specific wording that must be used in bypass trusts in order for them to "count," so it is important to use an experienced attorney when creating a bypass trust.