Credit Shelter Trust

In order to reduce or possibly eliminate estate (death) taxes, credit shelter trusts (aka bypass trusts) are often included in a living trust when a couple own significant assets.  Presently, a couple with combined assets approaching approximately $4,000,000 or more would benefit from a credit shelter trust (when calculating total assets, be sure to include all death benefits payable pursuant to any life insurance policies you own).       

Presently, each person has the right to shelter $2,000,000 worth of assets from estate taxes; Everything over that amount is taxed at 45%.  The goal of the credit shelter trust is to fully utilize this credit for each spouse.  Without a credit shelter trust, one tax credit is wasted when the first of a married couple passes and gives all of his or her assets to the surviving spouse.  Since estate taxes are 45% on all assets over the $2,000,000 credit, wasting one will result in paying an additional $900,000 in taxes to the IRS, money that could have gone to your children or other heirs instead.  Here is an example of two couples, one with a credit shelter trust and one without: 

Another benefit of credit shelter trusts is that their assets grow tax-free.  In the example above, if the $2,000,000 in the trust grows to $2,500,000 at the wife's death, the gain of $500,000 will not be subject to estate taxes when she dies.  This avoidance of estate taxation on asset appreciation is why credit shelter trusts are sometimes referred to as asset freezing devices. 

One perceived disadvantage of this trust is that the surviving spouse does not have unfettered access to the assets the deceased spouse left in the trust (the trust owns the assets).  However, the trust may be created to allow him or her most of the benefits of ownership:

  §  The surviving spouse may serve as the trustee and manage the assets (including their sale and/or purchase of other assets);

  § He or she may receive the income generated by the trust for life;

  § The trust may be created to allow the surviving spouse to invade the principal for her health, maintenance, education or support at a level he or she is accustomed to;

      § The trust can even be created to allow the surviving spouse to invade up to 5% of the principal each year for any reason;

  § Even though the surviving spouse does not legally own the assets in the trust, he or she can be given a special power to change who will receive the trust assets after his or her death.  For example, the amount each child receives could be adjusted to reflect their present needs.  "Ungrateful" heirs could be excluded.  A charity could be included.  If the surviving spouse remarries, his or her new spouse could be excluded.

WITH CREDIT SHELTER TRUST

When husband passes, his $2,000,000 interest in the estate goes into the credit shelter trust.  Since his tax credit shelters $2,000,000, no estate taxes are owed.  Wife is entitled to all of the income produced by the trust and can even invade the principal under certain circumstances.  When wife passes, her estate worth $2,000,000 (the assets in the trust are not included in her estate) is shielded from taxes by her credit.  Assuming no growth or depletion of assets, this couple is able to give their children $4,000,000, $900,000 more than the couple without the credit shelter trust.

                     WITHOUT CREDIT SHELTER TRUST

Husband and wife have combined assets totaling $4,000,000.  Husband dies first and leaves his $2,000,000 interest in the estate to wife.  No estate taxes are owed at husband's death because the marital deduction allows spouses to pass unlimited assets to one another after death tax free.  However, when wife passes, she must pay estate taxes on the entire $4,000,000 combined estate (assuming no growth or depletion of assets).  After using her credit to shelter $2,000,000 from taxes, her estate must pay taxes of $900,000, leaving a total of $3,100,000 for her children or other heirs.