If your spouse died before 2018 and the estate plan created a credit shelter trust, bypass trust, family trust, or “Trust B,” that trust was built to solve a problem that no longer exists for most New Jersey families. It may now be creating one. Bypass trust modification may be the solution.
We help surviving spouses, trustees, and their advisors evaluate and modify legacy bypass trusts so that appreciated assets receive a step-up in basis at the surviving spouse’s death. Robert Aufseeser presented on this topic for the New Jersey Institute of Continuing Legal Education in June and July 2026.
Until 2017, New Jersey taxed estates above $675,000. The federal exemption was also a fraction of what it is today. Couples with a house, a brokerage account, and a retirement plan were told, correctly, that the first spouse’s exemption would be wasted unless assets went into a trust at the first death instead of outright to the survivor. The bypass trust kept those assets, and their growth, out of the survivor’s taxable estate.
New Jersey no longer imposes an estate tax on deaths after January 1, 2018. The federal exemption is $15 million per person for 2026 and indexed thereafter. For a surviving spouse whose own assets plus the trust fall well under that figure, the trust saves no estate tax at all.
What it does instead is freeze basis. Assets owned by the survivor get a new basis equal to fair market value at death, so the children can sell without capital gains tax on a lifetime of appreciation. Assets in the bypass trust do not. They pass to the children with the basis they had when the first spouse died, often twenty or more years earlier. A trust funded with $1 million of stock and real estate in 2004 that is worth $3 million today hands the children $2 million of taxable gain. At combined federal and New Jersey rates, that is a six-figure tax bill the family would never have owed if the assets had simply passed to the surviving spouse.
If all four are true, a modification is very likely worth evaluating. If the family does not get along, or the beneficiaries include people other than your descendants, the analysis is harder but not necessarily off the table.
The goal is to cause the trust assets to be included in the surviving spouse’s estate for federal tax purposes, which triggers the basis step-up, without actually exposing the assets to estate tax or giving up the trust’s protections. The most common tool is a carefully limited general power of appointment granted to the surviving spouse, drafted so that it applies only to appreciated assets, only to the extent inclusion will not generate estate tax, and only in a way that does not change who ultimately receives the property.
New Jersey law provides several routes to get there:
This is tax planning, not form-filling, and three risks have to be managed in every case.
Beneficiary consent as a gift. The IRS has taken the position that when beneficiaries consent to a modification that shifts value, they may be making a taxable gift. A modification that is drafted so the beneficiaries’ economic interests do not change avoids the issue; one that is not can create a gift tax problem for the children while solving the basis problem.
Over-inclusion. A general power of appointment that is too broad can pull the entire trust into the survivor’s estate and, in a larger estate, create the very estate tax the trust was built to avoid. The formula has to be tied to the survivor’s remaining exemption.
Collateral effects. Inclusion in the survivor’s estate can affect creditor exposure, Medicaid eligibility, generation-skipping transfer tax allocation, and the trust’s treatment under the terms of a prenuptial or divorce agreement. Each has to be checked before anything is signed.
Where the facts are unusual or the dollars are large, a private letter ruling from the IRS can provide certainty before the modification is implemented. We will tell you in the Stage 1 review whether that is worth the cost and time.
Stage 1: Bypass Trust Modification Basis Review. A fixed-fee review of the trust instrument, the funding history, current holdings and basis, the surviving spouse’s own estate, and the beneficiary structure. You receive a written memo stating whether a modification is worth doing, which route fits, what each beneficiary would be asked to sign, the gift-tax analysis, and a fixed-fee quote for implementation.
Stage 2: Design and Implementation. Drafting the modification and the power of appointment, the gift-tax analysis and documentation for consenting beneficiaries, obtaining consents or court approval, and coordinating with your CPA on the trust’s Form 1041 and any Form 709 reporting. Where a private letter ruling is recommended, it is quoted and handled separately.
If you prepare a Form 1041 each year for a trust created at a spouse’s death, and that trust holds appreciated assets while the surviving spouse’s estate is under the exemption, your client has this problem. The question is only whether the fix is worth more than it costs, and the Stage 1 review answers that. We take a 15-minute call with you first, at no charge, and we work through you on all reporting. For attorneys, we are available as co-counsel on the tax analysis, drafting, and any ruling request while you keep the client relationship. We do not pay or accept referral fees.
What is a bypass trust?
A trust funded at the first spouse’s death with assets up to the then-available estate tax exemption. It gives the surviving spouse income and often access to principal, then passes to the children without being taxed in the survivor’s estate. It is also called a credit shelter trust, family trust, exemption trust, or Trust B.
Why don’t the assets get a step-up in basis when I die?
Because the trust was deliberately designed to keep them out of your taxable estate. The basis step-up at death applies to property included in the decedent’s estate. Excluded property keeps its old basis.
Can we just terminate the trust and distribute everything to me?
Sometimes, but it is usually not the best answer. Termination may itself be a gift by the remainder beneficiaries, it gives up creditor and remarriage protection, and it may conflict with a material purpose of the trust. A targeted modification generally accomplishes the basis goal with fewer side effects.
Do all of the children have to agree?
For a consent modification under N.J.S.A. 3B:31-27, yes, all beneficiaries must consent, though New Jersey law allows certain beneficiaries to be represented by others with substantially identical interests. If consent cannot be obtained, court modification under N.J.S.A. 3B:31-28 remains available.
How long does this take?
A consent modification with cooperative beneficiaries is typically completed within two to four months of the Stage 1 review. Court modification adds several months. A private letter ruling adds roughly a year.
If your spouse died before 2018 and a trust is still filing tax returns, request a Bypass Trust Basis Review.