This article discusses what you need to know about a credit shelter trust, including:
- What is a credit shelter trust?; and
- What are the benefits of a credit shelter trust?
What is a credit shelter trust?
The credit shelter trust, also known as a Family Trust, has long been the gold standard for estate planning. With each spouse able to move over $5 million adjusted for inflation and federal portability without a sunset clause, the issue of whether credit shelter trust preparation is still appropriate or advisable has emerged. The reality is that the credit shelter trust is still a great choice because it can be used for so many things other than estate tax planning.
What are the benefits of a credit shelter trust?
The credit shelter trust can be used to balance the needs of blended families; it can be used to secure assets from creditors; it can be used to shield assets in the event that a surviving spouse remarries and divorces.
The credit shelter trust may also protect the federal exclusion's growth, while portability only protects the exclusion's value on the date of death. Let's say the deceased partner passed away while the exclusion was $5.49 million. Let's also assume a 6% wealth growth rate and a surviving spouse who lives for 12 years. The credit shelter trust would be entirely exempt at death and worth $10.98 million if the assets were deposited in it. Only the $5.49 million deduction will be required to offset the $10.98 million if portability was used. To cover the growth of the assets left to them outright, the surviving partner would have to use a large portion (or all) of their own exclusion.
In addition, a credit shelter trust will be able to keep the generation-skipping exemption. This is important since the applicable exclusion is portable, but the GST exemption is not. The GST exemption will prevent assets from being taxable in the children's estates.
The credit shelter trust can be an important estate planning tool, particularly for blended families. When the first spouse passes away, the deceased spouse's properties are transferred to the credit shelter fund. If the assets surpass the available exclusion, the excess may be put into a marital deduction-eligible trust or given directly to the surviving partner. The credit shelter trust is irrevocable, which helps ensure that the assets it retains are maintained for the decedent's heirs in addition to providing estate tax benefits. The surviving spouse is usually entitled to the trust's income (though they are not required to have any rights), which accounts for the surviving spouse's care over their lifetime, while the decedent's children have peace of mind knowing that the credit shelter trust's assets will be available to them. This removes the possibility of a new step-parent receiving all of the money meant for the children. If required, the trustee may be granted authority to use the credit shelter trust's assets to meet the surviving spouse's needs, which must meet an ascertainable standard, such as health, education, maintenance, and support. Of course, a disinterested trustee will be the right person to make these decisions. The marital deduction-eligible trust would also be irrevocable. The surviving spouse would be entitled to any profits from the trust. It is possible, though not necessary, to grant the surviving spouse rights to the principal.
The benefits of using a credit shelter trust have already been discussed. Although they are most beneficial to blended families, they also provide significant benefits for traditional first marriage families. What are some of the drawbacks? There is no step-up in basis when the surviving partner dies in a standard credit shelter trust. Since the credit shelter trust is a different taxpayer, it also must file its own Form 1041 tax return.
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