Exempt Trust
An exempt trust is an irrevocable estate planning device by which married couples can double their federal estate tax exemptions by placing assets beyond the reach of estate taxes while distributing income to the surviving spouse and ultimately passing on wealth to heirs free of taxes.
With the federal estate tax exemption increasing to $13.99 million for each individual in 2025 (increasing to $15 million in 2026), exempt trusts remain one of the best strategies available to high-net-worth families to safeguard their heritage. Exempt trusts can save families up to tens of millions of dollars in taxes while securing financial security for surviving spouses.
What is an Exempt Trust?
An exempt trust, or bypass trust, credit shelter trust, or AB trust, is an enhanced estate planning device that is particularly designed for married couples with large assets. The primary purpose is to maximize the federal estate tax exemptions of both spouses and leave the surviving spouse with financial security.
When the first spouse dies, assets of an amount equaling that spouse's estate tax exclusion amount are moved into this irrevocable trust. These assets can accumulate and eventually pass to the couple's children or other dependents without being taxable to estates. In return, the surviving spouse can be given income from the trust and, in most cases, access to principal for health, education, maintenance, and support.
The "exempt" term refers to the authority of the trust to shield assets from the 40% federal estate tax imposed on wealthy individuals. Couples can transfer virtually $28 million tax-free to their heirs in 2025 by taking advantage of both spouses' exemptions.
How Exempt Trusts Work in Practice
The mechanism of an exempt trust is straightforward but effective. When a husband and wife marry, they establish their estate plan, and they leave instructions to have the trust be funded at the death of the surviving spouse. This is planned years ahead of when it will actually be needed.
Upon death of the initial spouse, the estate is essentially split into two. The assets of the deceased spouse up to their available exemption value are employed to establish the exempt trust. Any remaining assets pass either outright to the surviving spouse or into a further marital trust, both of which qualify for the unlimited marital deduction.
The exempt trust is irrevocable at funding, and no one can change its terms. But most times, the surviving spouse is the trustee and may receive all income the trust accumulates. Most exempt trusts allow the surviving spouse to take principal for some purposes like medical bills, education, or to live in the ordinary way they have been accustomed.
When the surviving spouse subsequently dies, exempt trust assets go directly to the named beneficiaries without being part of the surviving spouse's estate. These assets thus avoid estate tax entirely regardless of how much they've grown in value over time.
Current 2025 Estate Tax Exemption Amounts
Understand the existing exemption levels when determining whether an exempt trust is appropriate for your loved ones. The federal estate tax exemption in 2025 is $13.99 million per individual, an increase from $13.61 million in 2024.
Spouses are able to combine their exemptions, for a total of $27.98 million shelter. A couple, therefore, may transfer almost $28 million to their heirs tax-free under the federal estate tax, if they are forward-thinking with the utilization of exempt trusts.
The gift tax annual exclusion has further been increased to $19,000 per person in 2025 from $18,000 in 2024. With this, people can give big gifts throughout their lives without using any of their lifetime exemption.
It must be remembered, however, that these high exemption amounts are only for the moment. Unless Congress takes action, they were to plunge drastically in 2026. But that's all changed with the newly enacted One Big Beautiful Bill Act (OBBBA).
Types of Exempt Trusts
There are several variations of exempt trusts, each designed to fit unique family needs and circumstances. Having knowledge of these options helps families choose the best form for them.
Bypass Trusts
The most common is the traditional bypass trust. The first spouse's death has the amount of the exemption pay for this trust, and income passes to the surviving spouse with limited access to principal. The remaining amount passes to children or other designated beneficiaries at the death of the surviving spouse.
AB Trusts
AB trusts are a more sophisticated approach where the couple's assets are divided into two trusts upon the first death. The "A" trust (survivor's trust) is also revocable and fully in the control of the surviving spouse. The "B" trust (bypass trust) is irrevocable and includes the deceased spouse's exemption amount.
ABC Trusts
Others utilize ABC trusts, which provide a third component. The "C" trust typically provides room for assets qualifying for the marital deduction but far more comfortably than in the bypass trust. This provides even more flexibility in the management of very large estates.
Generation-Skipping Trusts (GST)
Generation-skipping trusts (GST) is a form, established to benefit grandchildren and "skip" the generation of children for taxation purposes. They are particularly beneficial for families that want to set up multi-generation wealth distribution plans.
Key Advantages of Exempt Trusts
The primary benefit of exempt trusts is to maximize estate tax savings. Families can potentially save millions of dollars in taxes which would otherwise be payable to the federal government by utilizing both spouses' exemptions.
Asset protection is another key benefit. After assets are where they should be, in an exempt trust, they're usually safe from the creditors of the surviving spouse. They're also safe from future spouses should the surviving spouse marry again, and assets end up reaching the true beneficiaries.
Exempt trusts provide control over the passing of assets. The grantor can specify exactly how and when inheritance passes to the beneficiaries. This control can be particularly beneficial in blended families where couples want to leave some assets to their biological children.
The trusts also shield against growth. Any growth in the trust assets occurs outside of both spouses' taxable estates. A $10 million exempt trust growing to $15 million in the future sends the entire $15 million to the beneficiaries with no additional estate tax.
Income to the surviving spouse provides a further level of benefit. The majority of exempt trusts are structured to distribute periodic payments of income so that the surviving spouse can maintain his or her lifestyle without depleting the principal for final beneficiaries.
Potential Disadvantages to Consider
Whereas their strength, exempt trusts have weaknesses that families should thoroughly consider. Loss of flexibility is the most significant weakness. After a trust has been rendered irrevocable, it cannot be changed by the surviving spouse or anybody else, even in response to shifting circumstances.
Administrative cost and hassle can be considerable. Independent tax returns, professional management, and ongoing legal conformance are required for exempt trusts. The cost can easily amount to tens of thousands of dollars annually, which can overshadow the tax savings for small estates.
The surviving spouse forfeits complete control of the trust assets. While they typically receive income and limited principal access, they are not free to use these assets at whim as if they were their own funds. This limitation is restrictive to spouses who were accustomed to exercising complete control of finances.
Income tax ineffectiveness is also a problem. Trust income is taxed under compressed tax brackets, meaning that the trust reaches a top tax rate earlier than individual taxpayers. This may result in higher total income taxes than assets held outright.
Loss of the step-up in basis upon death of the surviving spouse can be costly. Assets within exempt trusts are not given a new cost basis at the death of the surviving spouse and can lead to higher capital gains tax for beneficiaries than for assets that would have gone through the surviving spouse's estate.
Who Should Consider an Exempt Trust
Exempt trusts are most suited for married couples who have estates in combination close to or greater than current exemption levels. With 2025 exemptions of nearly $28 million combined, this will only happen for only the very wealthy families.
Second marriage couples generally benefit a great deal through exempt trusts. These trusts allow them to exclude their current spouse and provide for their biological children so that they inherit specific property. This can prevent conflicts between relatives and ensure everyone has something safeguarded.
Business owners commonly find exempt trusts helpful for succession planning. Business interests can be held by the trust, and surviving income goes to the spouse with the business passing down to children or other preferred successors later.
Real estate families with a large portfolio of real estate also find exempt trusts helpful. Real estate tends to appreciate over time, and investing such assets in an exempt trust removes all future appreciation from the taxable estate.
Couples seeking creditor protection should also look into exempt trusts. These vehicles provide substantial protection for future creditors of the surviving spouse and the ultimate beneficiaries.
Tax Implications and Requirements
Tax treatment of exempt trusts is complex and needs to be well-planned to maximize benefits. The IRS has regulations regarding the way these trusts must be created and handled so they qualify for their tax benefits.
The surviving spouse's access to trust assets must be limited to maintain the trust's tax benefits. Generally, distributions must be limited to health, education, maintenance, and support (HEMS standard) to avoid having the trust assets included in the surviving spouse's taxable estate.
They must file annually an income tax return on Form 1041. Exempt trusts are reporting entities separate from the taxpaying status of the trust and are subject to highly compressed income tax rates for the trust that extend to top rates at significantly lower income levels than individual tax units.
Generation-skipping transfer tax situations add an additional layer of complication. If the trust will ultimately be passed to grandchildren or further generation descendants, proper GST exemption allocation is critical to avoid the 40% GST tax.
State tax implications are radically different based on the state of creation of the trust and the location of the beneficiaries. There are estate tax-free states and states with substantial taxes having much lower exemptions than federal states.
Recent Changes Under OBBBA
The One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, has significantly impacted exempt trust planning. Most importantly, it permanently extended the plain exclusion amount of $15 million per individual from 2026 onwards with inflation adjustments annually.
This modification eliminates the previous uncertainty about the exemption levels dropping in 2026. Families may now plan securely and be sure that the higher exemption levels will endure forever. For married couples, this will mean a combined exemption of $30 million from 2026 onwards.
The duration of these higher exemptions should reduce the feeling of urgency that some families experienced to establish exempt trusts promptly. However, for families with estates above even these high levels, exempt trusts remain viable planning tools.
The OBBBA also modified a few rules relating to charitable gifts that may impact trust planning techniques. These changes must be carefully examined with estate planning professionals to become most tax-effective.
Real-World Examples
Example 1: John and Sarah
Consider John and Sarah, a married couple with an aggregate estate worth $35 million. When John dies in 2025, his $13.99 million exemption amount covers an exempt trust. Sarah owns all the income from the trust and can spend principal on her health and care expenses.
When Sarah subsequently dies, her $13.99 million exemption shields additional property, and the exempt trust leaves all of its value (plus any increase) to their children outright. This strategy could save the family a few million dollars' worth of estate tax compared to leaving everything in the outright to Sarah.
Example 2: Michael and Lisa
Another example is that of Michael and Lisa, both of whom have children from a previous marriage. Michael's exempt trust ensures his biological children inherit his property while providing Lisa with income for life. At Lisa's death, her own property goes to her own children, so that the two families can divide the property equally.
Establishing an Exempt Trust
Establishing an exempt trust requires advance planning and the assistance of specialists. The process normally begins years prior to the trust ever becoming funded as part of comprehensive estate planning.
It is essential to have qualified estate planning attorneys. They understand the complicated IRS regulations and can draft trusts to secure the greatest benefits and remain within compliance. The exact wording of trust documents is critical for maintaining tax benefits.
Families must also hire experienced trustees who know how to handle trust administration. Most families use corporate trustees because they are proficient and unbiased, although some use individual trustees who are familiar with the family.
Regular review and updating ensure the trust continues to meet the family's requirements. Even though the trust itself is not revocable when funded, the family should review their overall estate plan periodically to account for changed laws, shifting family dynamics, and shifting asset values.
Conclusion
Exempt trusts continue to be formidable tools of wealthy married couples looking to optimize their estate tax savings as well as care for surviving spouses. Today's exemptions of almost $28 million combined and increasing to $30 million in 2026 make these trusts available only to the very wealthiest families.
The choice to create an exempt trust is balancing considerable tax savings against lower flexibility and higher complexity. For families with estates larger than current exemption levels, the tax advantages are usually greater than the drawbacks. For smaller estate families, though, simpler planning techniques might be preferable.
The recent amendments of OBBBA introduce more certainty for long-term planning, eliminating past concerns about shrinking exemptions. Such certainty makes families feel secure regarding planning and enjoying one of the most effective wealth transfer methods.
Success with exempt trusts requires expert guidance from experienced estate planning attorneys, tax advisors, and trustees. Experts can help families navigate through the complex rules and make their trusts receive maximum tax efficiency while fulfilling their unique family goals.
With careful planning and implementation, exempt trusts can save families millions of dollars in taxes while also securing the financial future of widowed spouses and enduring legacies for generations to come. For the appropriate families, these trusts are one of the most valuable estate planning devices that exists today.
