Credit Shelter Trusts

 

Summary

 

This item discusses credit shelter trusts and how married couples use them to reduce their estate tax liability.

 

 

 

Important: State Laws Vary

 

It is critical to note that state law varies on how trusts are executed and interpreted, It is important that clients consult with their legal professional prior to executing any estate planning document.

 

•   What is a credit shelter trust?

•   Example

 

 

 

What is a Credit Shelter Trust?

 

A credit shelter trust is an estate-planning document that may help married couples reduce their estate tax liability.

 

The credit shelter trust (also sometimes called a bypass trust , A-B trust, or family trust) is tax-driven. It is designed to benefit a spouse and/or other family members, and to utilize both spouses’ applicable exclusion amount to pass the most wealth onto their beneficiaries.

 

The IRS treats transfers of assets for individuals in two separate and distinct ways:

 

•   Non-marital transfers (transfers to someone other than your spouse), which are taxable transfers

•   Marital transfers (transfers to a spouse), which are nontaxable transfers

 

The IRS currently allows a tax credit of $780,800 for the first type of transfer, which enables one to pass up to $2 million free of estate taxes. The Taxpayer Relief Act of 2001 enacted legislation that gradually increased the applicable exclusion amount each year until it reaches $3.5 million in 2009. The second type of transfer is a marital deduction that enables the surviving spouse to defer the taxes until death. The marital deduction is unlimited.

 

When planning one’s estate, it is important to recognize that everyone is able to transfer up to $2 million in assets free of federal estate taxes. It is critical to note that this is a “use or lose” credit. If one transfers all their assets directly to their surviving spouse, they will effectively lose all of their available lifetime exclusion amount. The remaining amount of the dollars transferred to the surviving spouse will be included in the estate of the surviving spouse, thereby incurring potential increased estate tax at the death of the surviving spouse.

 

The only way to preserve one’s exclusion amount and ensure that one’s spouse receives income and principal, if desired, is by using a credit shelter trust.

 

Additional benefits of the credit shelter trust are protection of the trust assets from the creditors of

 

beneficiaries and avoidance of probate for the trust assets.

 

A grantor can serve as his or her own trustee, or the grantor can appoint a family member or corporate trustee to serve. Edward Jones Trust Company can serve as either current trustee or successor trustee for your client.

 

 

 

Example:   Credit Shelter Trust

 

Here’s an example of how a credit shelter trust can be used to reduce estate taxes.

 

Two couples, the Atkins and the Walls, have each accumulated $4 million in assets.

 

The first couple, Bob and Mary Atkins, have all of their assets titled in joint tenancy with rights of survivorship. When the first spouse dies, all the assets will pass to the surviving spouse, thereby avoiding probate. Remember, this would not be the case if the assets were passing under a will to the surviving spouse.

 

The second couple, John and Ruth Wall, have planned their estate with revocable living trusts using a credit shelter trust strategy. This means that a portion of their exclusion amount can be used when the first spouse dies.

 

When Bob Atkins dies, the assets pass to Mary, avoiding estate taxes by utilizing the marital deduction. Remember, the marital deduction defers only the transfer taxes until the second spouse’s death. When Mary dies (assuming she passes these assets to their children under her will), the assets will pass through probate and be subject to a federal estate tax of $846,000. In addition, probate costs will be approximately $120,000 (assuming a 3% fee for probate and legal costs).

		Bob and Mary Atkins	John and Ruth Wall
Vehicle:		Joint tenancy with rights of survivorship	Credit shelter trust
Total estate value:		$4,000,000	$4,000,000 •   John’s trust: $2,000,000 • Ruth’s trust: $2,000,000
At the death of the first spouse:		At Bob’s death, all his assets pass directly to Mary, thereby avoiding probate.	At John’s death, John’s $2,000,000 is transferred into the credit shelter trust for the benefit of Ruth, and Ruth retains her $2,000,000 in her living revocable trust.
At the death of the second spouse:		Estate tax: $846,000* Probate fees: $1 20,000**	Ruth’s estate: $2,000,000 Probate fees: $0 Estate tax: $0
Assets to heirs		$3,154,000	$4,000,000 Ruth’s $2,000,000 and the $2,000,000 in John’s credit shelter trust.
Total John and Ruth saved by using the credit shelter trust:			$846,000

 

Tax on $4,000,000 (minus $120,000 probate fees) is $1,626,800. Individual’s credit on $4,000,000 is $780,800, leaving a tax liability of $846,000.

 

**                  Probate and legal fees estimated at 3% of total estate.

Reduce Estate Taxes Through a Credit Shelter Trust

The credit shelter trust is not created until after the death of the first spouse. Rather, the provisions to create a credit shelter trust are included in your will or revocable living trust. At that time, an amount equal to the applicable exclusion is set aside in the credit shelter trust. The surviving spouse can receive any income from the trust and may have access to the principal.

At the death of the second spouse, assets in the credit shelter trust are distributed to heirs as directed in the trust document. Because the surviving spouse has limited control over the distribution of the trust assets, the assets remaining in the credit shelter trust at the death of the second spouse are not considered part of the survivor's taxable estate.