What are credit shelter trusts?
A credit shelter trust (CST) is a trust created after the death of the first spouse in a married couple. Assets placed in the trust are generally held apart from the estate of the surviving spouse, so they may pass tax-free to the remaining beneficiaries at the death of the surviving spouse. The assets held in the CST can benefit the surviving spouse during their lifetime. Credit shelter trusts are also commonly known as bypass, family, or exemption trusts.
How do they work?
Because transfers to surviving spouses are generally free from federal estate tax, CSTs can be used in conjunction with the unlimited marital deduction. At death, if the executor or trustee is directed to fully fund the CST, assets totaling the deceased spouse's available lifetime federal gift and estate tax applicable exclusion amount would be transferred to a CST for the benefit of the surviving spouse for their lifetime. When the surviving spouse dies, the trust assets will pass tax-free to the CST beneficiaries. The CST shelters the assets and any appreciation in the value of the assets from inclusion in the surviving spouse's estate.
To derive the maximum federal estate tax benefit, each spouse should own enough assets in their own name so the value of each spouse's assets meets (to the fullest extent possible) or exceeds the applicable exclusion amount.
CST vs. portability
At the election of the surviving spouse, the Internal Revenue Code provides for the transfer of the first-to-die spouse's unused applicable exclusion amount to the surviving spouse, who can then use it for their gift or estate tax purposes.* Although relying on portability may be easier than creating and administering a CST, a CST has several advantages over electing portability:
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Considerations
When consulting with your attorney or tax advisor, consider the possible downsides to a credit shelter trust:
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