A credit shelter trust (CST) is a trust created after the death of the first spouse in a married couple. Assets placed in the trust are generally held apart from the estate of the surviving spouse, so they may pass tax-free to the remaining beneficiaries at the death of the surviving spouse. The assets held in the CST can benefit the surviving spouse during their lifetime. Credit shelter trusts are also commonly known as bypass, family, or exemption trusts. Because transfers to surviving spouses are generally free from federal estate tax, CSTs can be used in conjunction with the unlimited marital deduction. At death, if the executor or trustee is directed to fully fund the CST, assets totaling the deceased spouse’s available lifetime federal gift and estate tax applicable exclusion amount would be transferred to a CST for the benefit of the surviving spouse for their lifetime. When the surviving spouse dies, the trust assets will pass tax-free to the CST beneficiaries. The CST shelters the assets and any appreciation in the value of the assets from inclusion in the surviving spouse’s estate. To derive the maximum federal estate tax benefit, each spouse should own enough assets in their own name so the value of each spouse’s assets meets (to the fullest extent possible) or exceeds the applicable exclusion amount. At the election of the surviving spouse, the Internal Revenue Code provides for the transfer of the first-to-die spouse’s unused applicable exclusion amount to the surviving spouse, who can then use it for their gift or estate tax purposes. Although relying on portability may be easier than creating and administering a CST, a CST has several advantages over electing portability: All appreciation in the value of the assets in the CST bypasses the surviving spouse’s estate and will not be subject to federal and/or state estate taxes at the surviving spouse’s death. Portability is generally not permitted for state estate tax exclusions (for states that levy state estate tax) and the federal generation-skipping transfer tax exclusion. Therefore, without the use of a CST, any unused state estate tax exclusion and generation-skipping transfer tax exclusion of the first spouse to die will be lost. Assets contained in a trust are generally protected from the beneficiary’s creditors. The first spouse to die can control where the assets remaining in the trust are distributed after the surviving spouse’s death rather than relying on the surviving spouse to carry out the wishes of the first spouse to die. Estate Planning ConsiderationsWhen consulting with your attorney or tax advisor, consider the possible downsides to a credit shelter trust: Portability is now a permanent part of the federal estate tax system, which means each spouse’s estate tax exclusion that is unused at death is “portable” and can be carried over to the surviving spouse. Portability was enacted as a temporary provision in 2011, but Congress has made this important provision permanent. Portability can simplify estate planning significantly. Before portability, married couples had to divide and re-title ownership of their assets between them so that each had about the same level of net worth. Their will (or revocable trust document) also had to establish a trust on the death of the first spouse in the amount of the estate tax exclusion. This path fully used the couples’ estate tax exclusions, and effectively “sheltered” the assets by funding what is termed a “credit shelter trust.” This trust is sometimes called the “bypass trust” because it bypasses the taxable estate of the surviving spouse. It’s also called the “B Trust” in A/B trust planning or simply the “family trust” because in addition to estate tax savings, it provided for the family of the decedent after death, including the surviving spouse, children, and potentially even the grandchildren. Compared to a credit shelter trust, portability is simple. A husband and wife can put together a basic will that leaves all of their assets to each other, without the complication of a trust. A long-married couple often prefers the ease of having their assets in joint tenancy. Portability works well with jointly held assets as well. How Credit Shelter Trust is FundedThere are generally two ways to fund the credit shelter trust. A Credit Shelter Trust Hypothetical ExampleAssume Jim and Mary’s combined taxable estate is worth roughly $2 million and is divided equally between them. Jim dies in 2004. Without a credit shelter trust, all of his assets would pass to Mary estate tax free because of the marital deduction, making Mary’s total estate worth $2 million. If Mary were to die in 2005, the first $1,500,000 of her estate would be exempt from estate taxes. However, the remaining $500,000 would be subject to $225,000 in taxes, leaving only $1,775,000 for her beneficiaries. This taxable event would happen because only one unified credit was used for Jim and Mary’s joint estate. With a credit shelter trust. Jim would stipulate that at his death $1,500,000 would go directly into a credit shelter trust, to help provide lifetime income for Mary. Because Jim’s assets had been put into the trust, Mary’s estate would be worth $1,500,000. If Mary were to die in 2004, her $1,500,000 would not be subject to federal estate taxes because it would be equal to the amount protected below her federal tax credit. Hypothetically, Jim and Mary could save their beneficiaries $225,000 in federal estate taxes. Estate Planning AB Trusts and Portability of the Estate Tax ExemptionNote that beginning in 2011, the federal estate tax exemption was made transferable between married couples. This is referred to as “portability of the estate tax exemption” and means that if one spouse dies in 2011 or later and his or her entire federal estate tax exemption is not needed to avoid estate taxes, then the unused portion of the deceased spouse’s estate tax exemption can be added to the surviving spouse’s estate tax exemption. This, in essence, means that in 2021 a married couple will be able to pass on up to $23.4 million on to their heirs free from federal estate taxes without the need to use AB Trust planning. If the spouses have different sets of final beneficiaries, such as in the case of a second or later marriage where each spouse has their own children that they want to inherit their separate assets after both spouses are deceased, then the couple will want to make use of AB Trust planning in order to ensure that their separate beneficiaries will be their ultimate beneficiaries. Finally, the federal generation-skipping transfer tax exemption is not portable, so couples who want to double the use of their GST exemptions will need to use AB Trust or ABC Trust planning to do so. How Credit Shelter AB Trust Planning WorksHere is how the AB Trust system works to maximize the use of both spouses’ estate tax exemptions: Credit Shelter Trust LawyerWhen you need a credit shelter trust, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
Ascent Law LLC
8833 S. Redwood Road, Suite C West Jordan, Utah 84088 United States Telephone: (801) 676-5506
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