Many trusts I review for Riverside and Roseville couples date from 2008, when the federal exemption from estate tax was $2 million. Most contain an A/B formula that, at the first death, sends the largest amount that can pass tax free into a "bypass" or "credit shelter" trust. Section 70106 of Pub. L. 119-21 rewrote 26 U.S.C. § 2010(c)(3) so the basic exclusion amount is $15,000,000 for 2026, indexed after 2026, with no sunset. Rev. Proc. 2025-32 confirms it. As of October 2, 2026 the IRS has not published the 2027 figure.
Should the formula come out? For most California couples well under $30 million I lean toward yes, though the tools depend on whether both spouses are alive. For a broader plan review, see our post on updating a California estate plan after Prop 19.
What does a mandatory bypass formula do when the first spouse dies?
The survivor’s share stays in her revocable trust. With a $15 million exemption, the formula sweeps the deceased spouse’s entire share into the B trust, which becomes irrevocable at death. The survivor usually gets income plus principal for her health and support, and the children take the remainder. Within 60 days the trustee must serve the notice required by Cal. Prob. Code § 16061.7. The survivor can no longer change who inherits that share.
Why does the bypass trust cost the children a second step-up in basis?
Under 26 U.S.C. § 1014, inherited property takes a basis equal to its value at death. Section 1014(b)(6) adds a California bonus: the survivor’s half of community property is also stepped up at the first death.
The bypass trust is built to stay out of the survivor’s estate, so it misses the second step-up. Her own assets are stepped up again when she dies, and so is QTIP marital trust property, because 26 U.S.C. § 2044 pulls it into her estate and section 1014(b)(10) resets its basis. The B trust gets nothing, and on a rental its depreciation stays baked in.
What does a funded bypass trust cost to run each year?
A funded B trust files its own Form 1041 and California Form 541. For 2026 a trust hits the 37 percent federal bracket above $16,000 of taxable income. 26 U.S.C. § 1411(a)(2) adds 3.8 percent on undistributed investment income above that line.
California is different. Cal. Rev. & Tax. Code § 17041(e) uses the single-filer schedule for trusts, so the state side is not compressed. The FTB’s 2025 Form 541 rate schedule starts 9.3 percent at $72,724 and 12.3 percent above $742,953, and under section 17742 the trust is taxable here if a trustee or noncontingent beneficiary lives here. The survivor-trustee also owes the children the duty under Prob. Code § 16060 to keep them reasonably informed.
When does a bypass trust still earn its keep?
Second marriages are the classic case, though a QTIP trust protects the first spouse’s children just as well and keeps the step-up. Generation-skipping planning is another. The GST exemption under 26 U.S.C. § 2631(c) equals the basic exclusion amount but is not portable, so the first spouse must use it at death, through a bypass trust or a reverse QTIP election under section 2652(a)(3). A spendthrift B trust under Prob. Code § 15300 also sits beyond the survivor’s future creditors and a new spouse.
On Medi-Cal, Welf. & Inst. Code § 14009.5 limits estate recovery to the probate estate and bars it while a spouse survives. Eligibility is different: DHCS reinstated an asset limit ($130,000 for one person) on January 1, 2026 and says it falls to $21,000 on July 1, 2027. Whether a bypass trust created through a living trust counts against the survivor turns on 42 U.S.C. § 1396p(d)(2)(A), which carves out trusts a spouse created by will (see our Medi-Cal planning page). A child living in Washington (about a $3 million exclusion) or Oregon ($1 million threshold) may owe that state’s estate tax at death on an outright inheritance. A continuing trust for that child can avoid it, even if the bypass formula goes.
How do portability and Form 706 fit in?
Without a B trust, portability is the backstop. The executor elects it under section 2010(c)(5)(A) on a timely return, due nine months after death under 26 U.S.C. § 6075(a) plus any extension. Rev. Proc. 2022-32 allows a late election up to the fifth anniversary of death for estates not otherwise required to file. The ported amount is not indexed, and the return must be complete, as our Estate of Rowland post explains. A Clayton plan always needs a Form 706 for the QTIP election, and Rev. Proc. 2016-49 keeps the IRS from voiding an unneeded QTIP election when portability is elected.
How do the numbers work for a Riverside couple with a 2008 A/B trust?
Take Dan and Laura, an illustrative Riverside couple with a 2008 A/B trust, a $1.9 million house and a $900,000 rental, all community property. Assume Dan dies in 2027 and Laura in 2037, when the house is worth $2.5 million and the rental $1.2 million.
Under the formula, Dan’s $1.4 million half funds the B trust, and section 1014(b)(6) steps all $2.8 million up at his death. At Laura’s death only her half is stepped up again. The B trust’s half of the house has a $950,000 basis against $1.25 million; its half of the rental has $450,000, less about $80,000 of depreciation, against $600,000. That is roughly $530,000 of gain, and at 15 percent federal plus 9.3 percent California the children owe about $129,000 if they sell, more if unrecaptured section 1250 gain applies.
With a full Clayton QTIP election, or a disclaimer plan where Laura disclaims nothing, all $3.7 million is stepped up at her death. Estate tax is zero under every design, and property tax does not change. Funding the B trust is excluded under Rev. & Tax. Code § 63, and the children’s change in ownership occurs at Laura’s death under Property Tax Rule 462.160(c). Section 63.2 shelters the house only if a child moves in within a year, and only up to the factored base year value plus $1,044,586 through February 15, 2027 (BOE LTA 2025/009). The rental is reassessed either way.
How do we change the trust while both spouses are living?
By amendment. Cal. Prob. Code § 15401 allows revocation by the trust’s method or, unless that method is exclusive, a signed writing delivered to the trustee, and section 15402 allows modification by the same procedure. Under Fam. Code § 761, community property keeps its character when modification requires both spouses, so both of you sign. If one spouse lacks capacity, a conservator can seek authority under Prob. Code § 2580(b)(11).
A disclaimer plan leaves everything to the survivor, who has nine months to disclaim part into a bypass trust under 26 U.S.C. § 2518 and Prob. Code § 275; under Treas. Reg. § 25.2518-2(e)(2) she may keep income and support-limited principal from that share. A Clayton plan, named for Estate of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992) and now reflected in Treas. Reg. § 20.2056(b)-7(d)(3)(i), gives the survivor a QTIP interest in whatever the executor elects; the rest goes to a bypass trust. For blended families I like that the executor, not the survivor, decides.
What if the first spouse has already died?
Then the B trust is irrevocable. Section 15404 needs the settlor’s consent, which a deceased settlor cannot give. Under section 15403 all beneficiaries can petition, but the court must find the reason outweighs any remaining material purpose. Section 15409 requires unanticipated circumstances that would defeat or substantially impair the trust’s purposes, a hard fit for a lost step-up. Both are brought by petition under Prob. Code § 17200(b)(13).
Decanting under the Uniform Trust Decanting Act, Prob. Code § 19501 and following, can work. A trustee bound by a health and support standard has only "limited distributive discretion" under section 19512 and must keep the new trust substantially similar. An independent trustee with broader discretion can, under section 19511(d) and (e), give the survivor a general power of appointment, pulling the assets into her estate under 26 U.S.C. § 2041 and restoring the step-up, after 60 days’ notice under section 19507.
| Feature | Mandatory A/B formula | Disclaimer plan | Clayton (QTIP) plan |
|---|---|---|---|
| Who decides, and when | Fixed when signed | Survivor, within 9 months | Executor, on Form 706 |
| Second step-up on first spouse’s share | No | Yes on what she keeps | Yes on the elected share |
| Remainder locked for first spouse’s children | Yes | Only on the disclaimed share | Yes |
| Form 706 required | Only for portability | Only for portability | Yes |
| Main risk | Lost step-up, annual 1041/541 | Survivor misses the deadline | Late or missed election |
Frequently Asked Questions
Is our old A/B trust invalid now that the exemption is $15 million?
No. The trust and its formula still work. With a $15 million exemption, though, it will usually push the entire share of the first spouse to die into the bypass trust, which may not be what you want. Whether to change it depends on your family and your real estate’s appreciation.
Can the surviving spouse skip funding the bypass trust?
Not safely. Once the first spouse dies, the B trust is irrevocable and the trustee must fund and administer it under its terms. Leaving it unfunded invites disputes with the children and personal liability for the trustee. If it no longer makes sense, petition the court or decant; do not ignore it.
Does switching to a disclaimer or Clayton plan change our property taxes?
Generally no. A transfer to a trust for a surviving spouse is excluded from reassessment under Revenue and Taxation Code section 63. When the survivor dies, the family home is tested under section 63.2 and rental property is reassessed under any design. The choice mainly changes income tax basis.
Do we need to file Form 706 if our estate is far below $15 million?
Not for estate tax, but often for portability, which lets the survivor keep the deceased spouse’s unused exclusion. Rev. Proc. 2022-32 allows a late portability election up to five years after death for estates not required to file. A Clayton plan needs one regardless.
What will the estate tax exemption be in 2027?
The IRS had not announced it as of October 2, 2026. The statute sets $15,000,000 for 2026 and indexes it for deaths after 2026, rounded to the nearest $10,000. The IRS usually publishes the next year’s figure in a fall revenue procedure, so check before relying on a projection.
How North Star Law Firm Can Help
North Star Law Firm reviews and amends older A/B trusts for married couples in the Inland Empire, the Sacramento area and across California, including conversions to disclaimer and Clayton designs within revocable living trusts, trust administration after a first death, and the Form 706, 1041 and 541 filings handled through our trust and estate tax return practice. Phillip Zagotti is a California attorney and a CPA who models the basis and income tax results before recommending a change.
If your trust was signed before the exemption reached $15 million, contact North Star Law Firm or schedule a consultation to see whether the bypass formula still fits.