Bypass trusts and first-death tax

Date: 2026-05-18
Educational only — not legal or tax advice. Confirm with an Illinois estate attorney and current law.

Abstract

A bypass trust (credit shelter trust, B trust, family trust) holds the first spouse’s estate tax exemption at first death so those assets (and often their growth) are not taxed again in the survivor’s estate. Federally, portability (DSUE) can sometimes achieve a similar result without a bypass; Illinois has no state portability, so bypass-style planning matters for Illinois couples near or above the $4M per-person exemption.

When tax is due: Estate tax is measured at each death, with returns and payment on statutory deadlines (often with extensions). Moving after someone dies does not undo that person’s estate tax; the survivor’s later move may change future exposure only. Moving before death can change which state taxes apply only with a bona fide domicile change and attention to asset situs—not intent alone.

1. The problem bypass trusts solve

1.1 Two exemptions, two deaths

Married couples often think in terms of one household. Tax law thinks in terms of two taxpayers. Each spouse has:

• A federal estate tax exemption (much higher than Illinois, with portability of unused federal exemption to the survivor in many cases).
• An Illinois exemption of $4,000,000 per person, with no portability—unused Illinois exemption at first death is generally lost unless planning uses it.

If the first spouse leaves everything outright to the survivor:

• Federal: Often no tax at first death (unlimited marital deduction), and the survivor may later use portability (DSUE) for federal purposes.
• Illinois: Often no tax at first death (marital deduction), but the first spouse’s $4M Illinois exemption may be wasted. The survivor’s estate swells; at second death, Illinois tax can apply to a much larger Illinois taxable base.

A bypass trust is the classic way to use the first spouse’s exemption at first death while still supporting the survivor.

1.2 Names mean the same thing (usually)

Do not confuse this with a revocable living trust used for probate avoidance—that is often a grantor trust during life and included in the estate at death unless it becomes part of a different structure at death.

2. How A–B planning works at first death

2.1 The split

A typical A–B plan at first death divides assets between:

1. Marital share (A trust / QTIP / outright marital bequest) — for the survivor’s benefit; often qualifies for the marital deduction (federal and often state), deferring tax on that portion until second death (subject to elections and Illinois quirks).
2. Bypass share (B trust) — funded up to the available exemption (federal, Illinois, or the lesser of what the plan targets); structured so the corpus is not included in the survivor’s estate at second death.

The document (will and/or revocable trust with disclaimer or formula clauses) tells the fiduciary how much goes to each bucket. Funding (retitling, beneficiary designations, executor/trustee actions) must actually happen—paper alone is not enough.

2.2 What the bypass trust looks like in practice

Common features (plans vary):

• Irrevocable at first death (the dead spouse’s portion is no longer revocable).
• Survivor’s rights: Often income for life, sometimes principal for health, education, maintenance, support (HEMS) or limited invasions—not unlimited control (too much control can pull assets back into the survivor’s estate).
• Other beneficiaries: Children or heirs after the survivor’s death.
• Trustee: Survivor may be co-trustee; independent trustee sometimes used for tax/formality reasons.
• Estate tax goal: Amount allocated to the bypass at first death is designed to be excluded from the survivor’s gross estate at second death; growth inside the bypass also stays outside (a major long-term benefit).

2.3 Simple numeric intuition (Illinois)

Assume Illinois resident, 100% Illinois situs, no adjusted taxable gifts, current law, and a plan that fully funds bypass with $4M at first death:

Exact dollars depend on total estate, marital funding, Illinois QTIP elections, and the interrelated Illinois calculation — see illinois-estate-tax-computation and illinois-estate-tax-chart-3.9m-6m ($3.8M–$10M).

3. Federal vs Illinois

Illinois-only QTIP (35 ILCS 405/2(b-1)): A state election on Form 700, independent of federal QTIP, used when federal exemption ≫ Illinois so you do not over-fund bypass in a way that triggers unnecessary Illinois tax at first death while still preserving Illinois exemption. Coordination is often bypass + marital/Illinois QTIP in the right proportions — see isba-illinois-qtip-bar-news and illinois-estate-tax-computation.

4. Implications

4.1 Tax

• First death: Bypass allocation uses exemption now; may reduce Illinois/federal tax at second death on bypass corpus and appreciation.
• Income tax: Bypass is usually not a grantor trust for the survivor (unlike a revocable living trust). Trust pays income tax under trust rules (compressed brackets) or distributes to beneficiaries with K-1s. Step-up in basis at first death applies to assets in the bypass to the extent they were includible in the decedent’s estate—important for highly appreciated assets.
• Second death: Assets remaining in bypass may get another step-up only for assets includible in the second decedent’s estate (often not the bypass corpus itself; marital/QTIP pieces differ). Tradeoff: estate tax savings vs income tax on sale later.
• GST tax: Large estates may need generation-skipping planning in bypass formulas.

4.2 Non-tax

• Administration: Separate EIN, trust accounting, annual tax returns, trustee duties.
• Asset control: Survivor may have less direct control over bypass assets than if everything were outright.
• Creditors/divorce: Trust terms may protect heirs better than outright marital property (depends on structure and state law).
• Remarriage: Bypass terms should address what happens if the survivor remarries (who benefits, who serves as trustee).
• Fairness among children: Bypass often benefits lineal descendants; marital share may differ—family politics matter.
• Funding failures: If IRAs, homes, or accounts never get allocated correctly, the plan fails in part—Illinois exemption wasted, probate fights, etc.

4.3 What bypass does not do

• Does not avoid tax on amounts above the funded exemption at first death (marital share is deferred, not erased).
• Does not replace funding the revocable trust or updating beneficiaries.
• Does not automatically help income tax during life (that’s a different trust type).
• Does not by itself fix inheritance tax in other states or federal tax if the estate is enormous—layered planning still required.

5. When is the estate taxed—first death or second?

5.1 Tax at each death

Estate tax is an event tax tied to a transfer at death (and some lifetime gifts). For a married couple:

Bypass planning shifts which pot is taxed when, not whether tax exists forever.

5.2 “No tax at first death” can be misleading

Outright to spouse often produces $0 Illinois tax at first death because of the marital deduction—but that can mean paying more later when only one $4M Illinois exemption remains.

Bypass at first death may also show $0 Illinois tax if the bypass is fully sheltered by the first $4M exemption—even though assets moved into an irrevocable structure. The point is preserving exemption, not necessarily writing a check today.

5.3 Deadlines (conceptual)

• Returns and payment have statutory due dates (often 9 months after death, with extensions commonly available for estate tax returns).
• Do not confuse “no tax due yet on marital share” with “no return required”—large estates may still need Form 700 and elections (e.g. Illinois QTIP) even when tax due is low or zero.

Exact deadlines and extensions: current Illinois AG instructions and federal IRS rules for the year of death.

6. Moving out of state

6.1 After the first spouse dies

The deceased’s estate tax is generally fixed by facts at their death:

• Domicile/residency at death (for state estate tax).
• Location/situs of each asset (real estate, tangible property, business interests, etc.).
• For Illinois residents, the estate typically includes worldwide assets except certain out-of-state real and tangible property (35 ILCS 405/5 pattern—verify current statute).

The survivor moving to Florida, Texas, etc. after the first death:

• Does not re-open or erase the first decedent’s Illinois return if they were an Illinois resident at death with Illinois-situs property.
• May change where the survivor pays income tax and what state taxes the survivor’s later estate at second death.
• Does not remove assets already in a funded bypass trust from the planning architecture—that trust continues under its terms.

Bottom line: Post-death relocation is not a reliable fix for first-death Illinois estate tax that was already triggered by residency/situs and estate size.

6.2 Before death (planning window)

Changing domicile before death can change which state’s estate tax applies for that person’s death, but only if the change is real:

• Domicile = true home, with intent to remain—not a vacation home or a mailbox.
• States look at: time in state, home ownership, driver’s license, voter registration, doctors, family ties, where you file resident income tax returns, etc.
• Illinois apportionment: Even for some non-residents, Illinois-situs assets (e.g. Illinois real estate) can still attract partial Illinois estate tax via the situs fraction on Form 700.

Survivor who moves before second death might avoid Illinois estate tax on the survivor’s worldwide estate if they become a bona fide non-resident of Illinois—but:

• Illinois real estate and certain tangible property may still be taxed.
• Federal estate tax still applies if over federal threshold.
• Income tax on trust undistributed income continues.
• Step-up and trust situs issues remain.

6.3 Move assets vs move people

There is no general rule that heirs get a post-death period to “move the estate out of Illinois” before tax is computed. Tax is tied to death and asset location/type, not where beneficiaries live afterward.

6.4 Interaction with bypass at first death

If first death already funded a $4M Illinois bypass:

• Those assets are outside the survivor’s estate for second-death Illinois tax (if structure is correct).
• Survivor moving to a no-estate-tax state before second death may further reduce tax on what the survivor still owns outright and on marital/QTIP balances—but not magically recharacterize the first death or undo Illinois tax properly due on the first return.

7. Timeline (married couple, Illinois, illustrative)

flowchart LR
  subgraph life [During life]
    R[Revocable trust / wills]
    F[Fund assets; coordinate beneficiaries]
  end
  subgraph d1 [First death]
    A[Measure gross estate]
    B[Split: bypass up to exemption]
    C[Marital / IL QTIP for balance]
    D[File Form 700 if over 4M gross]
  end
  subgraph between [Survivor years]
    T[Trustee administers A and B]
    M[Survivor may move domicile - affects future tax only]
  end
  subgraph d2 [Second death]
    E[Tax survivor estate minus bypass]
  end
  life --> d1 --> between --> d2

8. Connection to the Illinois tax chart

The illinois-estate-tax-chart-3.9m-6m ($3.8M–$10M) shows Illinois tax on one tentative estate (100% IL situs, single death, no gifts). Married bypass planning is inherently two-death:

• First death: Tax depends on how much goes to bypass (exemption used) vs marital (deferred).
• Second death: Tax depends on survivor’s remaining estate minus bypass (and how QTIP/IL QTIP was elected).

Run the skill ~/.cursor/skills/illinois-estate-tax/scripts/il_estate_tax.py separately per death with appropriate line 1 and QTIP inputs—not one combined “household” estate.

The ~28.6% marginal band just above $4M on the chart is a quirk of the current Illinois credit/cap formula on a single estate curve—not a description of bypass itself.

9. Practical checklist (for counsel)

1. Combined net worth, split of assets, Illinois vs other situs?
2. Is Illinois Form 700 required at each death (gross > $4M)?
3. Target bypass funding: federal only, Illinois $4M, or both (formula clause)?
4. Need Illinois-only QTIP on Form 700?
5. Are retirement accounts (tax-deferred) part of the plan—often worst assets to fund bypass without careful design?
6. Who is trustee, and what control does the survivor retain?
7. If considering moving states, how many years of facts support new domicile before each death?

10. Summary

A bypass trust implements the first spouse’s estate tax exemption at first death by holding assets outside the survivor’s taxable estate, which matters enormously in Illinois because state exemption is not portable. Tax is assessed per death, with returns due on legal deadlines—not optionally “settled later” by moving. Moving after death generally cannot unwind the deceased’s Illinois estate tax; moving before death may change future liability only with a bona fide domicile change and attention to Illinois-situs property left behind.

Further reading