A credit trust is an irrevocable trust that a married couple builds into their estate plan so the first spouse to die can use their federal estate tax exemption instead of wasting it. When that spouse dies, assets up to the exemption amount move into the trust and stay outside the surviving spouse’s taxable estate for good. For 2026, the federal estate tax exemption is $15 million per individual, so a married couple using this structure can shelter up to $30 million from the 40% federal estate tax when both exemptions are fully preserved.1Internal Revenue Service. What’s New – Estate and Gift Tax
You’ll also see the same structure called a bypass trust, credit shelter trust, or AB trust. The names are interchangeable.2Legal Information Institute. Bypass Trust
Why the Structure Exists
Every individual has a personal estate tax exemption (technically, the “applicable exclusion amount”) that offsets federal estate tax on assets up to a set dollar value under the unified credit.3GovInfo. 26 USC 2010 – Unified Credit Against Estate Tax Without planning, most spouses leave everything to each other under the unlimited marital deduction, which passes assets tax-free between spouses.4Office of the Law Revision Counsel. 26 USC 2056 – Bequests, Etc., to Surviving Spouse The problem is what happens next. The first spouse’s exemption evaporates. When the surviving spouse eventually dies, the combined estate is taxed against a single exemption.
A credit trust prevents that loss. Instead of everything flowing to the surviving spouse, an amount up to the deceased spouse’s exemption flows into a separate irrevocable trust. The surviving spouse can still benefit from those assets, but the assets themselves are not part of the surviving spouse’s estate. Both exemptions get used.
How It Gets Funded
The trust is typically written into a revocable living trust or a will while both spouses are alive, but it has no independent legal existence until the first spouse dies. At that point it springs into being as a separate irrevocable entity.2Legal Information Institute. Bypass Trust
Funding is not automatic. The executor or successor trustee has to act. The trust document contains a formula — usually either a pecuniary formula (a specific dollar amount equal to the remaining exemption) or a fractional share formula (a fraction of every asset) — that determines exactly how much goes in. The executor values the deceased spouse’s assets, which for estates large enough to require it means filing IRS Form 706 within nine months of the date of death.5Internal Revenue Service. Instructions for Form 706 Then the trustee retitles the chosen assets out of the deceased spouse’s name and into the trust.
Which assets go in matters. Assets expected to appreciate are usually favored, because every dollar of future growth inside the trust stays outside the surviving spouse’s taxable estate. If $2 million in stock grows to $10 million over twenty years, all $10 million passes to the remainder beneficiaries free of federal estate tax.
What the Surviving Spouse Can Access
The surviving spouse doesn’t lose the assets. They just can’t have unrestricted control. If they did, the IRS would treat the trust as part of their taxable estate under the rules governing general powers of appointment, which pull property back into the powerholder’s gross estate.6Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment The trust design walks a careful line to give the surviving spouse real access without crossing that line.
Income for Life
The surviving spouse is typically named as the primary income beneficiary and receives all trust income — interest, dividends, rental income — for the rest of their life without restriction.
Principal Under the HEMS Standard
Access to principal is narrower. Distributions from the trust corpus are usually limited to an “ascertainable standard” tied to health, education, maintenance, and support, known as HEMS. The tax code specifically provides that a power limited to this standard is not a general power of appointment, which is what keeps the trust assets out of the surviving spouse’s estate.6Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment Medical bills, tuition, housing — yes. Luxury spending or gifts to third parties — no.
The Five-and-Five Power
Some credit trusts also give the surviving spouse an annual withdrawal right known as a “five-and-five power,” letting them pull out the greater of $5,000 or 5% of trust value each year with no justification required. The tax code treats a lapse of this power as a release only to the extent the lapsed amount exceeds that threshold, so the withdrawal right itself does not cause estate inclusion.7Office of the Law Revision Counsel. 26 USC 2514 – Powers of Appointment Unused amounts don’t carry forward.
Limited Power of Appointment
The surviving spouse may also hold a limited power of appointment, letting them decide at their death how the remaining trust assets get divided among a defined group such as the couple’s children or grandchildren. That power must specifically exclude the surviving spouse, their estate, their creditors, and the creditors of their estate as possible recipients. If any of those four could receive assets under the power, it becomes a general power of appointment and the whole trust gets pulled into the surviving spouse’s taxable estate.6Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment
Credit Trust vs. Portability
Since 2011, a surviving spouse has been able to claim the deceased spouse’s unused exclusion (DSUE) through portability, which transfers the unused exemption directly without a trust.8Internal Revenue Service. Estate Tax Portability accomplishes the same headline goal — both exemptions get used — with far less administrative work. So why still use a credit trust? Four reasons.
- Appreciation shielding. A credit trust protects all future growth on the assets placed inside it. Portability transfers a fixed dollar amount of exemption. If assets appreciate substantially between the two deaths, only the trust captures that growth tax-free.
- Creditor protection. Assets in a properly structured credit trust are generally shielded from the surviving spouse’s creditors, lawsuits, and future liabilities. Portability transfers an exemption, not asset protection.
- Blended family control. The credit trust locks in who ultimately inherits. The deceased spouse’s children are guaranteed their share regardless of what the surviving spouse does later, including remarriage. Portability leaves the surviving spouse in full control of the assets and free to redirect them.
- Legislative risk. The federal exemption has swung dramatically over the past two decades. A credit trust shelters actual assets at the exemption level in effect when the first spouse dies. Portability depends on the exemption remaining at least as generous when the surviving spouse dies, possibly decades later.
Portability has one significant advantage of its own: simplicity. It requires filing Form 706 to elect the DSUE amount, but it avoids the ongoing trust administration, annual tax filings, and trustee duties a credit trust creates. Critically, electing portability requires filing Form 706 on time even if the estate owes no tax. Miss the deadline and the deceased spouse’s unused exemption is gone.9Internal Revenue Service. Instructions for Form 706
The Step-Up in Basis Trade-Off
Here is the cost that gets overlooked. When someone dies, assets included in their taxable estate generally receive a “stepped-up” basis equal to fair market value at the date of death, wiping out all unrealized capital gains.10Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Assets in a credit trust get that step-up when the first spouse dies. They’re in that spouse’s gross estate. But when the surviving spouse dies, those same assets are not in the surviving spouse’s estate, which is the whole point of the trust. And because they’re excluded, they don’t get a second step-up.
Imagine $2 million in stock funds the credit trust at the first death, stepped up to $2 million basis. Fifteen years later it’s worth $8 million. When the surviving spouse dies, the children inherit the stock with the original $2 million basis. Sell it, and they owe capital gains tax on $6 million. Had the same stock instead been in the surviving spouse’s estate, they would have received a fresh step-up to $8 million and owed nothing.
For estates well below the combined federal exemption, the estate tax savings from a credit trust may be zero while the capital gains cost is very real. Many estate planners now use flexible designs that give the trustee or surviving spouse discretion over whether to fund the credit trust at all, based on what the tax picture actually looks like when the first spouse dies.
When State Estate Taxes Change the Math
The federal exemption is $15 million per person, but roughly a dozen states impose their own estate or inheritance taxes with much lower thresholds. Oregon starts at $1 million. Massachusetts sets its threshold at $2 million. Several others fall in the $1 million to $7 million range.
For a couple in one of these states, a credit trust can produce significant tax savings even if the estate is nowhere near the federal threshold. A $5 million combined estate in a state with a $1 million exemption could face a substantial state estate tax bill if both exemptions aren’t preserved.
Coordination matters. Some states have decoupled their exemption from the federal amount, so funding the credit trust to the full federal exemption could actually trigger state estate tax on the first death. Planners in those states often use a formula that funds the credit trust only up to the state exemption and rely on portability to capture the remaining federal exemption.
Who Actually Benefits
A credit trust earns its complexity in four situations: estates large enough that both spouses’ exemptions need active protection, families where substantial appreciation is expected, blended families where controlling ultimate inheritance matters, and couples living in states with their own estate taxes. It also delivers a layer of creditor protection that no amount of portability planning can match.
For a couple with a $4 million estate in a state with no estate tax, the administrative cost and lost second step-up will usually outweigh the benefit. A simple portability election gets both exemptions used with none of the ongoing complexity. The right answer depends on estate size, state of residence, family structure, and how much the first spouse wants to control where the assets ultimately land.