Is Your Old Bypass Trust Costing Your Heirs a Step-Up in Basis?
Last reviewed: August 2026
Yes, an old bypass trust can quietly cost your heirs a step-up in basis, and that lost step-up can turn into a six-figure capital gains bill. The reason is simple: a bypass trust step-up in basis happens only once, at the first spouse's death. Assets locked in that trust are excluded from the surviving spouse's taxable estate by design, so they get no second step-up when the second spouse dies. For most families today, that trade no longer saves any federal estate tax, and it can hand the next generation a tax bill on decades of growth.
Key Takeaways
- A bypass trust gets a step-up in basis only at the first spouse's death; its assets get no second step-up when the survivor dies.
- The 2026 federal estate tax exemption is $15 million per person and $30 million per couple, so most families owe no federal estate tax.
- Trapped growth in a bypass trust is taxed at up to 23.8% when heirs sell, combining the 20% capital gains rate and the 3.8% NIIT.
- Maryland still taxes estates over $5 million per person at rates up to 16%, so the state math deserves a separate look.
About the Author: Jeff Judge, CFP®, AEP®, ChFC®, CLU® is Managing Partner of Chesapeake Financial Planners in Forest Hill, Maryland. He has helped families and business owners across Harford County and the Baltimore metro area with estate and tax planning since earning his CFP® certification in 2013, using Chesapeake's signature process, the R.U.D.D.E.R. Method™. "The bypass trust is the most common place I see good 2008 advice quietly turn into a 2026 tax bill, because the document never got a second look," says Jeff Judge.
How does the bypass trust step-up in basis rule work?
A bypass trust blocks the second step-up because its assets are deliberately kept out of the surviving spouse's taxable estate. When someone dies, the assets in their taxable estate get a new cost basis equal to the date-of-death value. Sell an inherited stock the next week and the pre-death gain is wiped out for tax purposes. That reset is what the tax code calls a step-up in basis.
The catch sits in one requirement: the step-up applies only to assets included in the decedent's taxable estate. A bypass trust, also called a credit shelter trust, is built to do the opposite. At the first spouse's death it is funded and structured so those assets sit outside the survivor's estate. That exclusion was the whole point, and the same design that keeps the money out of the second estate also cuts it off from a second step-up.
Does a bypass trust get any step-up at all? Yes, once. The assets receive a step-up at the first spouse's death, when the trust is funded. Whatever they were worth that day becomes the locked-in basis. If those holdings grow for another twenty years, the heirs inherit the old basis and owe capital gains tax on all of that appreciation when they sell. There is no second step-up in basis coming.
Assets that went the other way, outright to the surviving spouse or into a marital trust counted in the survivor's estate, do get a second step-up at the second death. This is really a capital gains tax on inherited assets that most families never see coming.
Why did a bypass trust make sense in 2008 but not now?
In 2008, splitting an estate into a marital share and a bypass trust was exactly the right call. The federal estate tax exemption that year was $2 million per person. Before portability existed, a deceased spouse's unused exemption simply vanished if the family did not lock it in at the first death, and funding the bypass trust up to the exemption captured it. When exemptions sat at $600,000, then $1.5 million, then $2 million, that trade was worth making for almost anyone with meaningful assets.
Two things changed the math. First, the 2017 tax law doubled the exemption, and then the One Big Beautiful Bill Act made the higher number permanent at $15 million per person and $30 million per couple for 2026, with no scheduled drop. Second, estate tax portability now lets a surviving spouse carry forward the first spouse's unused exemption without a bypass trust at all, if the estate files the return and makes the election on time.
"When a trust built for a $2 million exemption is still running on autopilot at $15 million, that is not a plan anymore. It is an old habit nobody canceled."
That is how Jeff Judge, CFP®, puts it to clients who bring in a decades-old trust for a second look.
A household worth three, five, even ten million dollars sits nowhere near $30 million in combined exemption, so the bypass trust saves no federal estate tax. It is still doing its other job, though: keeping assets out of the survivor's estate and quietly cutting off the second step-up. The estate tax savings went to zero, while the basis cost only grew as the assets kept appreciating inside a trust nobody revisited. For a fuller picture of why the 2026 estate tax exemption changes the planning conversation, see our overview of the permanent $15 million estate exemption.
How much can a lost second step-up actually cost your heirs?
The cost lands in the mid six figures on a fairly ordinary estate. Take a bypass trust funded with $1.5 million of appreciated stock and real estate at the first spouse's death. Over the next eighteen years it grows to $4 million. At the second spouse's death, none of that $2.5 million in growth gets a step-up. When the heirs sell, they owe long-term capital gains tax on the full $2.5 million, at a top federal rate of 20%, plus the 3.8% net investment income tax for households over the income threshold. That is 23.8% combined at the federal level, before any state tax. Call it roughly $500,000 to $600,000 in federal tax on money that owed nothing in estate tax to begin with.
Here is the same estate, sorted by where each asset sat:
| Where the asset sat | Second step-up at survivor's death? | Federal tax on $2.5M of growth |
|---|---|---|
| Inside the bypass trust | No | Up to about $595,000 (23.8%) |
| Outright to spouse or in a marital trust | Yes | $0 on pre-death growth |
Who actually pays this bill? The heirs do, and usually years later, when they finally sell the inherited stock or property. The estate owed zero federal estate tax either way, so the bypass trust did not save this family from a tax bill that was never coming. It created one.
Does Maryland's estate tax change the bypass trust math?
Yes, and it is the reason the federal answer is not the whole answer for families here. While the federal exemption climbed to $15 million, Maryland kept its own estate tax with a $5 million per-person exemption, a threshold that has not moved since 2019 and is not indexed for inflation. The top Maryland estate tax rate is 16%. A household sitting at four million dollars can be nowhere near a federal estate tax problem and still be close enough to Maryland's line that the state math deserves its own look, separate from the federal question.
We work with a lot of Harford County families, in Forest Hill, Bel Air, and the surrounding towns, whose estates land in that three to eight million dollar range. For them a bypass trust can be pulling in two directions at once: doing nothing on the federal side, possibly still useful on the Maryland side, and burning a second step-up the whole time. The right call depends on the numbers, so it is worth mapping the Maryland estate and inheritance tax rules alongside the federal picture first.
Does keeping the bypass trust ever still make sense in Maryland? Sometimes yes. If the combined estate is large enough to face Maryland estate tax, or if there are non-tax reasons like a blended family or a beneficiary who should not control principal, the structure can still earn its place. The point is to decide on purpose, not by default.
What should you check in an old bypass trust?
Start by getting the actual trust document read, not summarized, by someone looking specifically at the funding formula and the trustee's discretion. Part of why this slips through is that no single person owns the job of catching it. The attorney who drafted the trust in 2008 is not monitoring what a 2026 law change means for a document already signed. The CPA doing the April return is looking at income tax, not a trust funding clause. The advisor managing the portfolio may never have read the trust at all. Everyone assumes someone else is watching. Usually nobody is. I have had this exact conversation with families who assumed their attorney would call if something changed, and most estate documents do not get reread until someone dies.
Here is what to look at:
- The funding formula. Does it force money into a bypass share up to the exemption, on autopilot, regardless of whether that share still saves any tax?
- Trustee discretion. Can the trustee choose not to fund the bypass share once it stops serving a purpose?
- Escape hatches. Newer documents often use a disclaimer trust or a Clayton contingent QTIP, which let the surviving spouse or executor decide after the first death whether funding a bypass share still makes sense. A credit shelter trust drafted in the 1990s or 2000s usually has none of that flexibility.
This is the kind of review the R.U.D.D.E.R. Method™ is built for. The R.U.D.D.E.R. Method™ is Chesapeake Financial Planners' six-step planning process: Review and Recognize, Uncover and Understand, Design and Develop, Discuss and Decide, Execute and Empower, and Reassess and Refine. An old trust is a textbook case for the Reassess and Refine step: right when signed, and outdated only because the law underneath it changed.
Ask the direct question. If the first spouse died today, would this document force money into a structure that costs more in future capital gains than it could possibly save in estate tax? If the answer is yes, that is a sign your plan may be outdated and worth revisiting.
Frequently Asked Questions
Does a bypass trust get a step-up in basis when the second spouse dies?
No. A bypass trust gets a step-up in basis only once, at the first spouse's death, when it is funded. Because the trust assets are excluded from the surviving spouse's taxable estate by design, they do not qualify for a second step-up. The heirs inherit the first-death basis and owe capital gains tax on all the growth in between.
What is the difference between a bypass trust and a marital trust for step-up purposes?
A marital trust is included in the surviving spouse's taxable estate, so its assets get a second step-up in basis at the second death. A bypass trust, also called a credit shelter trust, is excluded from that estate, so its assets keep the first-death basis. Same family, same plan, two very different capital gains outcomes.
Can you fix or unwind an old bypass trust?
Sometimes, depending on the document and state law. Options can include a trustee using discretion not to fund the bypass share, a nonjudicial modification, a trust decanting, or new documents drafted while both spouses are living. Each path has tradeoffs, so review the funding formula with an estate attorney and advisor before acting.
Does the $15 million estate tax exemption make bypass trusts unnecessary?
For many families, the federal estate tax reason for a bypass trust is gone, because the 2026 exemption is $15 million per person and $30 million per couple. But bypass trusts can still serve non-tax goals, such as providing for children from a first marriage or controlling how principal is spent. The tax case and the control case are separate decisions.
How does Maryland's estate tax affect bypass trust planning?
Maryland taxes estates over $5 million per person, a figure unchanged since 2019, at rates up to 16%. So a Maryland family well under the federal exemption can still face a state estate tax. That makes the bypass trust decision a two-part question here: it may do nothing federally while still mattering for Maryland, all while giving up a second step-up.
Ready to have your old trust actually read?
The bypass trust step-up in basis question comes down to one thing: does the old funding formula still earn its keep, or is it quietly handing your heirs a capital gains bill? If you have a bypass trust or credit shelter trust drafted years ago, it is worth confirming whether it still fits the 2026 exemption before it matters. Jeff Judge and the Chesapeake Financial Planners team work with families and business owners across Harford County and the Baltimore metro. Schedule a free fit call to review the funding formula while every option is still open.
A version of this article was originally published on Jeff Judge's LinkedIn.
Disclosures
The information provided is for educational purposes only and should not be construed as investment advice. Investment strategies should be tailored to individual circumstances, risk tolerance, and goals. Past performance doesn't guarantee future results. Consult with qualified financial professionals regarding your specific situation.
This information is not intended to be a substitute for specific individualized tax, investment or legal advice. We suggest that you discuss your specific situation with a qualified tax, legal or financial advisor.
Advisors associated with Chesapeake Financial Planners may be either (1) LPL Financial Registered Representatives offering securities through LPL Financial, Member FINRA and SIPC, and investment advisor representatives offering investment advice through Great Valley Advisor Group; or (2) solely investment advisor representatives offering investment advice through Great Valley Advisor Group and not affiliated with LPL Financial. Great Valley Advisor Group, and Chesapeake Financial Planners are separate entities from LPL Financial.
Chesapeake Financial Planners | 2402 Scotlon Ct, Forest Hill, MD 21050 | (410) 652-7868 | www.chesapeakefp.com
© 2026 Chesapeake Financial Planners | Not to be reproduced in whole or in part. All rights reserved.
