What Is a Credit Shelter Trust?
A Credit Shelter Trust (CST) is designed to allow affluent couples to reduce or completely avoid estate taxes when passing assets on to heirs, typically, the couple's children. This type of irrevocable trust is structured so that upon the death of the trust's creator or settler, the assets specified in the trust agreement and the income they generate are transferred to the settler's spouse.
Credit shelter trusts are trusts for affluent couples to minimize or avoid their estate tax liabilities by passing on proceeds from individual estates onto the partner's estate.
The estate, gift, and generation-skipping transfer tax (GSTT) is currently set at a $10 million base for individuals and a $20 million base for couples.
The CST allows a surviving spouse to maintain certain rights to the trust assets during the remainder of their lifetime.
Upon the surviving spouse's death, the trust's assets are transferred to the remaining beneficiaries without any estate taxes levied.
Credit shelter trusts are known as AB Trusts or Bypass Trusts. This is because CSTs are essentially bypass trusts in which each spouse has a separate "taxable" estate. These estates are known as A trusts and B trusts.
Understanding a Credit Shelter Trust (CST)
CSTs are created upon a married individual's death and funded with that person's entire estate or a portion of it as outlined in the trust agreement. These assets then flow to the surviving spouse. However, because the trust is managed by a designated trustee, the surviving spouse never actually takes control of the trust's assets. Therefore, the transfer does not add to the surviving spouse's taxable estate.
A key benefit to this type of trust is that the surviving spouse maintains certain rights to the trust assets during the remainder of their lifetime. Under specific circumstances, such as the need to fund certain medical or educational expenses, the surviving spouse can tap into the trust's principal and not just the income. Upon the surviving spouse's death, the trust's assets are transferred to the remaining beneficiaries without any estate taxes levied.
CSTs are known as AB Trusts or Bypass Trusts. This is because CSTs are essentially bypass trusts in which each spouse has a separate "taxable" estate. These estates are known as A trusts and B trusts.
The primary benefit of CSTs is that the surviving spouse can use the trust's principal and income during the remainder of their lifetime, for example, for medical or educational expenses. The remaining assets then pass to the beneficiaries and are not subject to estate taxes.
Credit Shelter Trusts (CSTs) and Tax Protection
CSTs are designed so that couples can take full advantage of estate tax exemptions. In 2020, the generation-skipping transfer tax (GSTT) exemption was $11.58 million for individuals and $23.16 million for couples. However, in 2019 it was 11.4 million (individual) and $22.8 million (couples). This lasts until December 31, 2025; that is, if Congress doesn't drastically update the Tax Cuts and Jobs Act before then.1
Benefits of a Credit Shelter Trust (CST)
The credit shelter trust has advantages beyond estate tax planning. A CST protects the assets of a surviving spouse and provides flexibility in distribution.
The CST protects the assets of a surviving spouse. For example, a surviving spouse’s assets are susceptible to creditors and possible depletion by children or a new significant other. The CST protects the assets from creditors and from being inappropriately used by the surviving spouse, for example, to pay the debts of a new spouse or their child.
Protecting the testamentary intent of the deceased spouse: In a blended family, each spouse may want to ensure that their share of the estate is passed to their chosen beneficiaries, children from a prior marriage, for example, and not just to the surviving spouse’s beneficiaries. The CST can help with this.
Flexibility in the trust’s distribution provisions: The trust language can incorporate a limited power of appointment for the surviving spouse. Thus, the surviving spouse may distribute the assets among a class of beneficiaries (e.g., “the issue of the deceased spouse”). An example is a child who did not need a special needs trust at the time the trust was drafted, but after the decedent spouse’s death, a special needs trust was preferred. In this case, the surviving spouse would be able to appoint the assets to a new special needs trust to provide for that child.
Maximize the Deceased Spouse's Generation-Skipping Tax (GST) Exemption
The GST exemption is not portable, the bypass trust can allocate the GST to a GST exempt bypass trust, preserving the GST exemption for lifetime children’s trusts.
Protecting growth on the assets from further estate tax on the surviving spouse’s death: A $5 million property or stock portfolio can be allocated to the CST on the decedent spouse’s death. The portfolio can be used by the surviving spouse and can grow to $8 million, then pass estate-tax-free to the bypass trust beneficiaries.
Property tax benefits. A distribution to a child from the CST is considered a transfer from the decedent spouse and not the surviving spouse. The distribution can take advantage of the decedent spouse’s $1 million non-residence parent-child property tax reassessment exclusion. An additional $1 million in reassessment exclusion can benefit spouses who own valuable rental or vacation properties.
Example of a Credit Shelter Trust
Suppose a husband and wife who have been married for several years each accumulate an estate worth $6 million, and the husband sets up a credit shelter trust to be funded upon his death with his share of their combined estate. After the husband dies, his $6 million estate and any income it generated passes estate-tax free to his wife because it falls below the federal exemption.
However, the transfer boosts the wife's net income to $12 million and past the estate-tax exemption. Because these assets were held in the trust outside of the wife's control, her taxable estate is still valued at $6 million and still within the estate-tax exemption. Thus, she can pass on her assets to her children estate-tax-free when she dies.
Credit Shelter Trust FAQs
How Do I Terminate a Credit Shelter Trust?
There are circumstances where if one spouse is deceased but the surviving spouse is still alive, the CST can be modified or terminated either by the trustee alone, by the trustee and all the beneficiaries, or by going to court. Consent of the beneficiaries is typically required.
What Happens When a Credit Shelter Trust Is Depleted?
In some cases, the value of a first decedent's gross estate may be reduced by deductions for debts, funeral expenses, and expenses of administering the estate, and it may not be large enough to use the estate tax exemption in full. In that event, the unused exemption can be preserved for the surviving spouse if the first decedent's executors make a portability election on a timely filed Form 706 (United States Estate [and Generation-Skipping Transfer] Tax Return).
What Is a Revocable Credit Shelter Trust?
The grantor, or the individual creating the CST, places the trust provisions in a will. The trust is revocable, and the grantor can change its terms at any time during their lifetime. It becomes an irrevocable trust when the person dies and assets, typically what remains of the estate tax exemption, go to the trust.
The surviving spouse may receive income from the trust’s assets. When the surviving spouse dies, the beneficiaries receive the trust’s asset estate tax-free. The trust relieves the heirs from worrying about unused estate tax exemptions.
Does a Credit Shelter Trust Have a Step-up Basis?
According to the legal firm Rudman Winchell, "Funding the credit shelter trust at the death of the first spouse provides a cost basis for those assets in the trust as of the date of death of the first spouse. However, because the assets in the credit shelter do not become part of the surviving spouse’s taxable estate, there is no second step-up in basis upon the surviving spouse’s death.2