What is a Credit Shelter Trust?
Credit Shelter Trust (CST), which is designed to help wealthy couples reduce or avoid estate taxes on assets passed to their heirs, usually the children, is called a Credit Shelter Trust. This irrevocable trust allows the spouse of the settler to receive the trust’s assets and income upon their death.
The Key Takeaways
- Credit shelter trusts allow wealthy couples to reduce or eliminate their estate tax liabilities. They pass on the proceeds of individual estates to the partner’s estate.
- The current estate, gift, and generation-skipping transfer taxes (GSTT) are set at $10 million for individuals and $20 million for couples.
- CST allows the surviving spouse to retain certain rights to trust assets for the rest of their lives.
- The trust assets are passed to the beneficiaries upon the death of the spouse who is not living. There are no estate taxes.
- Credit shelter trusts are also known as AB Trusts or Bypass Trusts. CSTs can be described as bypass trusts, in which each spouse owns a separate “taxable estate”. These estates are also known as A trusts or B trusts.
Understanding a Credit Shelter Trust (CST).
CSTs are established upon the death of a married person and funded from that person’s entire estate, or a portion thereof as specified in the trust agreement. These assets are then transferred to the spouse who is still living. The trust assets are managed by a designated trustee so the surviving spouse does not actually take control. The surviving spouse does not have any additional taxable estate as a result of the transfer.
This trust type has a key advantage: the spouse who survives retains certain rights to the trust assets for the rest of their lives. The trust’s principal can be accessed by the spouse who is unable to access the income. This could be in the case of a spouse who has been diagnosed with a serious illness or for educational purposes. The trust’s assets can be transferred to the beneficiaries upon the death of the spouse who is surviving. There are no estate taxes.
CSTs are also known as AB Trusts, bypass trusts, or Bypass Trusts. CSTs can be described as bypass trusts, in which each spouse owns a separate “taxable estate”. These estates are also known as A trusts or B trusts.
CSTs have the primary benefit that the spouse who is not living can still use the trust’s income and principal during their remaining lives, such as for educational or medical expenses. The remaining assets are then passed to the beneficiaries without estate taxes.
Credit Shelter Trusts and Tax Protection
CSTs were designed to allow couples to take full advantage of estate tax exemptions. For the generation-skipping transfer taxes (GSTT), the exemption for 2021 was $11.7 million for individuals and $23.4 million for couples. It was 11.58 million for an individual in 2020, and $23.16million for couples. If Congress does not update the Tax Cuts and Jobs Act, this will last until December 31, 2025.
Benefits of Credit Shelter Trust
Credit shelter trusts offer many benefits beyond estate tax planning. CST provides flexibility for distribution and protects the assets of the spouse who is not living.
Asset Protection
CST protects the assets of a spouse who has died. The assets of a surviving spouse are vulnerable to creditors, and possible depletion through children or new partners. CST protects assets from creditors and prevents them from being misused by the surviving spouse to pay off debts.
Protecting the testamentary intention of the deceased spouse: If you have a blended family, one spouse might want to make sure that their portion of the estate goes to their chosen beneficiaries. For example, the children of a previous marriage. Not just the spouse who died. This is where the CST can be of assistance.
Flexibility in trust distribution provisions: The trust language may include a limited power to appoint the spouse who is not incapacitated. The surviving spouse can distribute assets to a group of beneficiaries (e.g. “the issue of a deceased spouse”). A child that did not require a special need trust at the time of the trust’s creation, but was required by the deceased spouse after his death would be an example. In such a case, the spouse who is surviving would be able to appoint assets to a new special needs trust to care for the child.
Maximize the Exemption of Generation-Skipping Tax (GST), for the Spouse Who Has Died
The GST exemption cannot be transferred. A bypass trust can transfer the GST to a GST-exempt bypass trust. This will preserve the GST exemption for lifetime trusts for children.
To protect the growth of assets against the estate tax, a $5 million stock portfolio or property can be given to the CST upon the death of the spouse. The portfolio can be used to grow to $8,000,000 by the spouse who is still living. After that, the estate tax will not be paid to bypass trust beneficiaries.
Property tax benefits. The distribution of the CST to a child is considered a transfer by the decedent spouse, not the surviving spouse. You can use the $1 million non-residence parent/child tax reassessment exemption to make the distribution. Spouses with valuable vacation or rental properties may be eligible for an additional $1 million in reassessment exclusion.
Example of a Credit Shelter Trust
Let’s say that a married couple has an estate of $6 million. The husband creates a credit shelter trust which will be paid out when he dies with his share. His $6 million estate, including any income generated by it, is exempt from estate tax after the husband’s death. It falls under the federal exemption.
The transfer increases the net income of the wife to $12 million, which is above the exemption for estate taxes. These assets were not under the control of the wife, so her taxable estate remains at $6 million. However, it falls within the estate tax exemption. She can thus pass her assets on to her children, without having to pay an estate tax.
How do I terminate a credit shelter trust?
In certain circumstances, if one spouse dies but the spouse who is surviving is still alive, the CST may be terminated or modified by the trustee alone or by all beneficiaries. Usually, consent is required from the beneficiaries.
What happens when a Credit Shelter Trust is depleted?
Sometimes, the gross estate of the first decedent may be reduced by deductions for debts and funeral expenses. It may not be sufficient to qualify for the estate tax exemption fully. If the executors of the first decedent file a Form 706 (United States estate [and generation-skipping transfer] tax return), the exemption may be retained for the spouse who survives.
What is a Revocable Credit Security Trust?
The trust provisions are placed in a will by the grantor (or the person creating the CST). The trust can be revocable and the grantor may change its terms at any point during their life. When the person dies, the trust becomes an irrevocable trust and all assets, including the estate tax exemption, will go to it.
A trust may allow the spouse who is surviving to receive income. The trust’s assets are exempt from tax when the spouse who is surviving dies. The trust takes the worry out of the heirs’ minds about estate tax exemptions that have not been used.
Is there a step-up basis for a Credit Shelter Trust?
Rudman Winchell’s legal firm states that “Funding the credit trust at the death of the first spouse provides a cost basis for assets in the trust as of the date of death of the first spouse.” The assets in the credit shelter are not taxable and do not go into the spouse’s estate.
