March 14, 2007

Is funding the bypass trust optional?

Posted in Administration, Trust administration at 8:35 am

A common questionI encounter concerns the administration of a joint trust after the first spouse has died. In California, a typical living trust estate plan will take the form of a joint trust, which splits into two (or three) subtrusts when one of the spouses passes away.

The typical model is that the property that belonged to the person who passed away should be transferred into the “B” or Bypass trust. In some circumstances, another trust – referred to as the Q-TIP or “C” trust – will also be funding with some of the property from the person who passed away.

The other trust – the “A” trust, also known as the Survivor’s trust, holds the property of the spouse who is still living.

It’s not unusual for the surviving spouse – especially if they didn’t pay attention during the estate planning process, or if they used a trust mill or an attorney who couldn’t be bothered to explain the estate plan which was developed – to be surprised to learn that they’re obligated to take half of the property they’re accustomed to thinking of as “theirs”, and to move it into a new bank account or brokerage account.

(The exact details of the split between the A, B, and maybe C trusts depends on the property you own, how title was held (separate property versus community property), and the terms of your trust, so it’s not possible for me to describe exactly what to expect without actually reading your trust and understanding your property situation.)

In any event, unless the joint trust has been specially drafted to preserve flexibility at the first death, the trustee of the trust – typically the surviving spouse – is required to move assets into the bypass trust.

Why is this required? Because the different trusts – A, B, and C – are treated differently from a legal and from a tax point of view. For example, the B and C trusts are typically distributed according to the rules created by both spouses together; while the surviving spouse typically has the power to give the property in the A trust to anyone they choose.

In practical terms, this is most often an issue where the surviving spouse and the spouse who passed away had different ideas about who should receive their property – often because the surviving spouse remarries, or because this was a second marriage for one or both of the partners, and some of the children weren’t the biological offspring of both partners.

What happens if the bypass trust isn’t funded? The trustee – either the surviving spouse, during their lifetime, or the successor trustee – may face a lawsuit from frustrated beneficiaries, who are angry that their inheritance has been taken away from them or mismanaged.

1 Comment »

  1. karin marke said,

    September 29, 2007 at 8:13 am

    My father passed away 4 years ago and my mother (with her accountant) put her assets (House) into a bypass trust.
    When my father died, we had her house reappraised so that she can take advantage of the 250K tax exemption when she sold the house.
    We just found out that because the house is in the bypass trust, she is not eligible for such an exception. This came as a shock to use all (even her accountant). The only reason that we found this out was because her friend in a similar situation moved and found out that she was not elibible for that either.
    As my mother is thinking of downsizing and moving, is there any way to correct this? Any help would be appreciated.

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