DISCLAIMING ASSETS

AND TRUST FUNDING

One of the most common estate planning tools embedded in estate plans is a bypass trust. A bypass trust allows for a surviving spouse to disclaim, or refuse to accept, assets from a surviving spouse. Instead, they elect to transfer up to the applicable exemption amount, currently $3,076,000 in Washington state as of 2026, from the decedent spouse's estate to a bypass trust.

A bypass trust must have been established by the estate plan (will or trust) of the deceased spouse prior to death. This allows for removing assets from the taxable estate of the surviving spouse.

The most common pitfall we see occur with estate plan execution is for a surviving spouse to miss this nine-month deadline to formally disclaim specific assets to fund the bypass trust. If this deadline is missed, the bypass trust loses nearly all of its designed tax benefits.

There is a lot of coordination involved to make the best decisions on which assets to transfer into these bypass trusts. Often times, this cannot be accounted for ahead of time given asset appreciation and life changes. This coordination is one of the areas where we excel and enjoy doing for our clients.  

Most bypass trusts are designed with necessary restrictions around the ability of the surviving spouse to access and take income from the trust's assets. In example, distributing income each year is different from distributing capital gains. Income, such as dividends or rental income is possible to distribute to the surviving spouse up to an ascertainable standard for the "HEMS" health, education, maintenance, and support of the surviving spouse, without risking inclusion of the trust's assets in the surviving spouse's taxable estate. However invading principal and/or distributing capital gains from asset sales to the surviving spouse risks inclusion of the trust's assets in the surviving spouse's taxable estate.

Investment management of the trust becomes its own art and science to satsify the goals of the estate plan and the needs of the surviving spouse. The bypass trust will be required to file taxes each year and pay taxes on any income it doesn't distribute in the taxable year to the surviving spouse or other beneficiaries. This is where careful planning is needed to determine the best design for the trust's portfolio of assets. The balance between active income generation versus growth and appreciation become critical. Structuring income generation for tax efficiency for the surviving spouse, given the active income (dividends and interest) will be distributed to the surviving spouse in each tax year. And identifying the best growth assets from the onset given buying and selling assets will cause recognized taxable gains retained by the trust (not distributed to the surviving spouse) and therefore taxed at the trust level. Trusts, like estates, have compressed tax brackets. Meaning they pay the highest tax rates on income at much smaller income amounts than individuals - 37% tax rate on ordinary income over $16,000 and 23.8% tax rate on long term capital gains over $16,250 as of 2026.