Paralegal Advanced Competency Exam (PACE) Practice Exam

What type of trust is also known as a credit shelter trust?

1. A family trust

2. A bypass trust

3. An irrevocable trust

4. A living trust

The correct answer is: A bypass trust

A credit shelter trust, also referred to as a bypass trust, is designed to maximize estate tax exemptions for a married couple. It allows the estate of one spouse to pass assets to the surviving spouse while ensuring that a certain amount of that estate is sheltered from estate taxes when the surviving spouse passes away. The primary function of a bypass trust is to take advantage of the estate tax exemption limit, which prevents a significant portion of an estate from being taxed upon the death of the first spouse. By placing assets into a bypass trust, those assets are not included in the surviving spouse's estate, thus avoiding tax liabilities on that amount when they eventually pass the assets to their heirs. The other types of trusts listed do not serve this specific function of avoiding estate taxes in the same manner. A family trust generally refers to any trust that benefits family members and does not inherently carry the same tax-controlling features as a bypass trust. An irrevocable trust, while it may have tax benefits, doesn't function specifically as a credit shelter. A living trust, on the other hand, is created during a person's lifetime to manage their assets and can be revocable or irrevocable but does not inherently offer the tax safeguards provided by a bypass trust.