This is another in a series of blogs on the basics of estate planning. This week, we’ll look at credit shelter trusts.

The gold standard for estate planning has been the credit shelter trust, often called a Family Trust. With each spouse being able to pass $5 million adjusted for inflation ($5.49 million in 2017) and with federal portability without a sunset provision, questions have arisen as to whether credit shelter trust planning is still necessary or advisable. The truth is, the credit shelter trust continues to be a great option because it has so many uses that go beyond estate tax planning.

1. The credit shelter trust can be used to balance the needs of blended families;
2. The credit shelter trust can be used to protect the assets from creditors;
3. Such a trust can be used to shield assets in the event that a surviving spouse remarries and subsequently divorces;
4. The credit shelter trust also can shield the growth on the federal exclusion while portability only preserves the date of death value of the exclusion. For example, let’s assume the deceased spouse died when the exclusion was $5.49 million. Let’s further assume asset growth of 6% and a surviving spouse living another 12 years. If the assets were placed in the credit shelter trust, the trust would be completely excluded at death and would be worth $10.98 million. If portability were relied upon, only the exclusion of $5.49 million would be available to cover the $10.98 million. The surviving spouse would have to use much (or all) of their own exclusion to cover the growth of the assets left outright to them.
5. Further a credit shelter trust may preserve generation skipping exemption. This can be very important because, while the applicable exclusion is portable, the GST exemption is not. GST exemption can keep assets from being taxable in the estates of the children.

Especially for blended families, the credit shelter trust can be a critical estate planning tool. At the death of the first spouse, the assets of the deceased spouse are placed into the credit shelter trust. If the assets exceed the available exclusion, the excess can go into a trust qualifying for the marital deduction or to the surviving spouse directly. The credit shelter trust is irrevocable, which in addition to offering estate tax advantages, also helps guarantee that the assets it holds will be preserved for the decedent’s descendants. The surviving spouse typically is entitled to the income from the trust (thought need not have any rights at all), which provides for the surviving spouse’s support during their lifetime, while the decedent’s children have the security of knowing that the credit shelter trust’s assets are there for them. This eliminates concerns about a new step-parent getting all the money intended for the kids. If desired, the trustee may be given discretion to dip into the assets of the credit shelter trust for the needs of the surviving spouse, as outlined in an ascertainable standard, such as health, education, maintenance, and support. Of course, it would be best to have a disinterested trustee make these determinations. The trust qualifying for the marital deduction would also be irrevocable. That trust would be required to pay all income to the surviving spouse. The surviving spouse could be given rights to principal, but that is not required.

The advantages of using a credit shelter trust have been outlined above. While they are most useful for blended families, there are powerful advantages for traditional first marriage families, as well. What are the disadvantages? First, in a standard credit shelter trust, there is no step-up in basis at the death of the surviving spouse. However, in the Academy trust, there is language causing inclusion in the estate of the survivor and hence a step-up in basis, to the extent it does not cause a taxable estate. Thus, you can have your cake and eat it, too. Second, the credit shelter trust is a separate taxpayer and requires its own tax return, Form 1041.

In upcoming blogs, I’ll discuss more on the basics of estate planning.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com