A bypass trust lets you pass assets from one person to another while avoiding taxation.

Commonly used in the United States for estate planning, bypass trusts can work as a credit shelter to help protect your estate as a married American living in Canada.

Bypass trusts (also known as A/B trusts) can reduce or defer your U.S. estate tax if used when you draft your will. These testamentary trusts change the inheritance so that the surviving spouse doesn’t directly inherit the estate and become subject to higher estate tax exposure.

They can also be drafted to protect assets for your children or surviving spouse, even in the event that your spouse chooses to remarry.

You may have heard that the America Taxpayer Relief Act, colloquially called the fiscal cliff act, makes these trusts unnecessary because the surviving spouse is entitled to take the unused exemption from the deceased’s estate.

However, there are still many reasons why you should use these trusts:

  • They can be drafted to protect assets for your children or surviving spouse, regardless of whether the surviving spouse chooses to remarry.
  • Bypass trusts provide your beneficiaries with asset protection from creditors.
    • Your assets could increase in value and would be subject to exposure if they’re held directly by your surviving spouse.
    • Administration of the estate could be reduced given the formality of such trusts.

Using bypass trusts is not a blanket solution for all U.S. citizens living in Canada, but can offer considerable protection for your estate in the often complicated arena of cross-border planning.

Terry F. Ritchie, CFP (U.S.), RFP (Canada), TEP, EA, is cross-border tax expert.