If you’re married, it’s time to review your estate plan to determine if your will or revocable trust directs your assets into a credit shelter trust (CST). Formerly the one-size-fits-all approach favored by most estate planning professionals to minimize taxes for couples, recent tax law changes rendered many CSTs unnecessary. Moreover, under current law, credit shelter trusts may actually increase taxes.
Understanding the credit shelter trust
Each individual has an estate tax exemption, which, at death, can be used to shelter assets from estate tax. Traditionally, wills or revocable trusts directed that, upon the death of the first spouse, assets equal in value to the exemption would pass to a CST and the balance of the first spouse’s assets would pass to or be held in trust for the surviving spouse. Upon the surviving spouse’s death, the CST assets, including any accumulated income and appreciation, would be excluded from the surviving spouse’s estate, escaping estate tax. Without a credit shelter trust, if the surviving spouse inherited all of the assets and the combination of the inherited assets and the surviving spouse’s own assets exceeded her exemption, estate tax was incurred. For this reason, estate planning professionals have typically recommended a CST for married couples whose combined assets were likely to exceed the exemption.
However, credit shelter trusts have a number of drawbacks:
- If CST assets appreciate in the time between the deaths of the two spouses, heirs will bear the burden of higher income taxes.
- Assuming the credit shelter trust earns more than a nominal income, a separate tax return must be filed annually. Trusts pay income tax at the highest federal rate (currently 39.6%, plus a 3.8% surtax on net investment income) for ordinary income in excess of $12,150. By comparison, an individual is not in the top tax bracket unless his income exceeds $406,750.
- The beneficiaries of the CST after the surviving spouse’s death – typically children and grandchildren – are entitled to annual trust accountings.
- Although the surviving spouse is permitted to be a trustee of the CST, distributions by the spouse to herself must be limited to an “ascertainable standard,” such as health, support and maintenance, to avoid adverse tax consequences.
Tax law changes
Under current law, a credit shelter trust is unnecessary for many couples. The estate tax exemption is now up to $5,340,000 per spouse and will increase for inflation in future years. Moreover, the exemption is now “portable” between spouses, meaning that any exemption not used by the first spouse is generally available to the surviving spouse. Portability eliminates estate tax, provided the surviving spouse dies with less than the combined value of both spouses’ exemptions. That means, even without a CST, there would be no estate tax if the surviving spouse dies with $10,680,000 or less.
Even couples with assets in excess of $10,680,000 may be better off without a credit shelter trust. For these couples, the usefulness of a CST in minimizing taxes is based on several factors, including, but not limited to, the following:
- The relative estate and income tax rates when the spouses die, including state income taxes to which the heirs may be subject
- The amount of time between the spouses’ deaths
- Rates of return on the couple’s investments
- The surviving spouse’s pattern of spending
Instead of locking yourself into a credit shelter trust, your will or trust can be revised to defer the decision after the first spouse’s death. Then, the surviving spouse or personal representative, with the help of estate planning professionals, would determine based on information available at the time (e.g., relative tax rates, life expectancy of the surviving spouse, anticipated rates of return) whether a CST is beneficial.
A qualified estate planning professional can review your estate plan to ensure that a credit shelter trust does not wind up unnecessarily complicating your family’s lives or increasing taxes. Contact me or another member of our estate and trust team to learn if a credit shelter trust is right for you.
Scott Goldberger, J.D., is an estate and trust director in Kaufman Rossin’s Boca Raton office. Kaufman Rossin is one of the top CPA firms in the U.S. and offers a wide variety of services for high-net-worth individuals. Scott can be reached at firstname.lastname@example.org.