The heirs of wealthy spouses face a hefty tax burden following their parents’ deaths, according to the United States tax code. The credit shelter trust (CST) is a tax vehicle meant to shield a significant percentage of the deceased’s estate from taxes, thereby saving their children’s inheritance. Affluent spouses frequently use the CST to enhance the heredity of their assets.
The Credit Shelter Trust is subject to complicated tax regulations as well as a unique set of conditions. Learn how to use the CST to your advantage and reduce your estate tax burden.
What is a Credit Shelter Trust?
A Credit Shelter Trust (CST) is intended to assist wealthy couples to decrease or eliminate estate taxes when passing assets on to heirs, often the couple’s children. This sort of irrevocable trust is designed so that upon the death of the trust’s creator or settler, the assets indicated in the trust agreement and the income they generate are transmitted to the settler’s spouse.
Credit Shelter Trust and How They Work
The maximum estate tax rate under current U.S. law is 40% of the value of the estate that exceeds $11.7 million—the current estate tax exemption limit.
Spouse, on the other hand, can gift their estates to each other tax-free at any time, including when one of the spouses dies.
The CST is intended to take advantage of these laws in order to reduce the eventual tax rate that heirs must pay. Once a CST is established, the assets of the spouse who dies first will be transferred to the trust rather than to the surviving spouse, if the spouses hold their assets independently. The CST is then managed by a trustee, but it is intended to help the surviving spouse over their lifetime, for example, by giving income and granting access to cash for medical and educational expenditures.
The estate did not enhance the surviving spouse’s tax base since the deceased spouse’s assets were transferred to a trust rather than to the surviving spouse. As a result, upon the death of the second spouse, the residual assets in the CST will pass to the heirs tax-free, reducing the heirs’ tax burden. The value of the second spouse’s estate, as long as it is less than the estate tax exemption threshold, can also pass to the heirs without being subject to estate tax.
The purpose of the CST is to protect the assets. Creditors cannot collect from the trust since the trust does not belong to the surviving spouse. The primary is also safeguarded against depletion by a second spouse, the surviving spouse’s new stepchildren, or the like.
Credit Shelter Trusts (CSTs) and Tax Shelters
CSTs are intended to allow spouses to fully utilize estate tax exemptions. Individuals’ generation-skipping transfer tax (GSTT) exemption in 2020 was $11.58 million, while couples’ exemption was $23.16 million. In 2019, however, it was 11.4 million (individual) and $22.8 million (couples). This will be in effect until December 31, 2025, unless Congress significantly updates the Tax Cuts and Jobs Act before then.
What is the Tax Treatment of Income from a Credit Shelter Trust?
A Credit Shelter Trust is also known as a Bypass or AB Trust. It enables both spouses to benefit from estate tax exemptions. The provisions of the CST are included in the Grantor’s Will, which is another name for the individual who creates the Trust. To fully safeguard an estate from taxation, both spouses can establish CSTs.
The surviving spouse is entitled to the Trust’s income. They do not, however, usually have access to the principal. If the surviving spouse also dies, assets in the Trust flow to other heirs listed in the CST. This enables couples to pass down their estates to remaining family members, such as children, in a tax-efficient manner.
When the surviving spouse dies, the estate is distributed to the final beneficiaries by the CST. In most cases, inherited money is not taxed. That’s because the individual who died had already paid taxes on the money before passing away. There are, of course, exceptions, such as when the estate exceeds the federal estate and gift tax threshold. A knowledgeable Estate Planner can assist you in navigating the legal complexities.
The Advantages of a Credit Shelter Trust (CST)
The credit shelter trust provides benefits other than estate tax planning. A CST protects a surviving spouse’s assets and allows for distribution flexibility.
#1. Asset safeguarding
The CST safeguards a surviving spouse’s assets. For example, the assets of a surviving spouse are vulnerable to creditors and probable depletion by children or a new significant other. The CST protects the assets against creditors and from being improperly utilized by the surviving spouse, such as paying the obligations of a new spouse or their child.
Protecting the deceased spouse’s testamentary intent: In a blended family, each spouse may want to ensure that their share of the estate is given to their selected beneficiaries, such as children from a previous marriage, rather than solely to the surviving spouse’s beneficiaries. The CST can assist with this.
The distribution provisions of the trust can be flexible: The trust language can include a limited power of appointment for the surviving spouse. As a result, the surviving spouse may divide the assets among a group of beneficiaries (for example, “the deceased husband’s issue”). For example, suppose a child did not require a special needs trust when the trust was created, but after the decedent spouse died, a special needs trust was chosen. In this instance, the surviving spouse could transfer the assets to a new special needs trust to provide for the child.
#2. Maximize the Generation-Skipping Tax (GST) Exemption of the Deceased Spouse
Although the GST exemption is not transferrable, the bypass trust can transfer the GST to a GST exempt bypass trust, keeping the GST exemption for lifetime children’s trusts.
Protecting asset growth from further estate tax on the death of the surviving spouse: On the death of the deceased spouse, a $5 million property or stock portfolio can be assigned to the CST. The surviving spouse can use the portfolio, which can grow to $8 million and then pass estate tax-free to the bypass trust beneficiaries.
#3. Property tax breaks.
A distribution from the CST to a child is considered a transfer from the decedent spouse rather than the surviving spouse. The decedent spouse’s $1 million non-residence parent-child property tax reassessment exclusion can be used for the distribution. Spouses who own valuable rental or vacation homes may benefit from an additional $1 million in reappraisal exclusion.
Credit Shelter Trust Example
Assume a husband and wife who have been married for numerous years amass an estate worth $6 million each, and the husband establishes a credit shelter trust to be funded with his part of their combined estate upon his death. Because the husband’s estate is less than the federal exemption, his $6 million estates and any income generated by it transfer tax-free to his wife after he dies.
The transfer, however, raises the wife’s net income to $12 million, pushing her above the estate-tax exemption. Because these assets are kept in trust and are not under the wife’s control, her taxable estate is still $6 million and falls within the estate-tax exemption. As a result, when she dies, she can leave her possessions to her children tax-free.
How Do I Put an End to a Credit Shelter Trust?
If one spouse dies but the surviving spouse is still alive, the CST can be changed or terminated by the trustee alone, by the trustee and all of the beneficiaries, or by going to court. Beneficiaries’ consent is usually necessary.
What Happens If a Credit Shelter Trust Expires?
In some situations, the amount of a first decedent’s gross estate may be decreased by deductions for debts, funeral expenses, and estate administration expenditures, and it may not be big enough to take advantage of the estate tax exemption as its whole. In that case, the surviving spouse can keep the unused exemption provided the first decedent’s executors make a portability election on a timely completed Form 706. (United States Estate [and Generation-Skipping Transfer] Tax Return).
What is the meaning of a Revocable Credit Shelter Trust?
The trust provisions are placed in a will by the grantor or the one who creates the CST. The trust is revocable, which means that the grantor can amend the provisions at any moment throughout their lifetime. When the person dies, the trust becomes irrevocable and assets, typically the remainder of the estate tax exemption, are transferred to it.
The trust’s assets may provide income to the surviving spouse. When the surviving spouse dies, the trust’s asset estate is tax-free to the beneficiaries. The trust relieves the heirs of the burden of unutilized estate tax exemptions.
Is there a step-up basis in a Credit Shelter Trust?
“Funding the credit shelter trust at the death of the first spouse gives a cost basis for those assets in the trust as of the date of death of the first spouse,” according to the law firm Rudman Winchell. However, because the assets in the credit shelter are not included in the taxable estate of the surviving spouse, there is no second step-up in basis upon the surviving spouse’s death.
Credit Shelter Trust vs Marital Trust – Is a Marital Trust the Same as a Credit Shelter Trust?
No, a Marital Trust is a Credit Shelter Trust. A Marital Trust can be used by you and your spouse to leave assets to a surviving spouse, children, or grandchildren. When the person listed in a Marital Trust dies, the assets pass to the Trust, and the surviving spouse can use the Trust’s income but not the principal.
Marital Trusts include a Power of Appointment, QTIPs, and Estate Trusts. Before deciding which of these estate planning strategies to include in your Will, it’s critical to understand each of them and how they might benefit you and your family.
Credit Shelter Trust Limits
Credit shelter trusts are particularly effective when each spouse’s assets exceed the estate tax exemption threshold. They are not commonly employed when estates are less than the exemption amount.
Conclusion
A credit shelter trust is one of several types of trusts that can be useful tax management instruments for estates big enough to be subject to the federal estate tax. They can also be useful in ensuring that surviving spouses obey a deceased spouse’s instructions regarding asset disposition. Credit shelter trusts can keep assets out of the time-consuming and expensive probate proceedings. They can also protect a married couple’s assets from creditors if one spouse dies. This, however, will necessitate the services of an estate counsel.
Credit Shelter Trust FAQs
Is a credit shelter trust revocable or irrevocable?
You can amend the provisions of the trust at any moment throughout your life since it is revocable. When you die, it becomes an irrevocable trust, and assets – usually the remainder of your estate tax exemption – are transferred to the trust. The surviving spouse is now eligible to collect income from the trust’s assets.
Can a credit shelter trust be broken?
Beneficiaries of the credit shelter trust may have conflicting interests and needs. One option is to amend the credit shelter trust, but can this be done without damaging the tax benefits? “Yes, in some situations,” is the answer.
Can surviving spouse be trustee of marital trust?
The surviving spouse, like the credit trust, may serve as trustee of the marital trust, allowing him or her the authority to invest assets as he or she sees fit and take income or principal for his or her own health, support, and maintenance.
