What Is a Credit Shelter Trust (CST)?
A Credit Shelter Trust (CST) is intended to help wealthy couples to decrease or eliminate inheritance taxes when passing assets on to heirs, often the couple’s children. The assets listed in the trust agreement, as well as the income generated by them, are transmitted to the settler’s spouse upon the death of the trust’s founder or settler.
- Credit shelter trusts are trusts used by wealthy couples to reduce or eliminate their inheritance tax liability by transferring revenues from separate estates to the partner’s estate.
- Individuals pay a $10 million estate, gift, and generation-skipping transfer tax (GSTT), while couples pay a $20 million GSTT.
- The CST permits a surviving spouse to retain some rights to trust assets for the rest of their life.
- When the surviving spouse dies, the trust’s assets are distributed to the remaining beneficiaries without regard for estate taxes.
- Credit shelter trusts are often referred to as AB Trusts or Bypass Trusts. This is due to the fact that CSTs are effectively bypass trusts in which each spouse has their own “taxable” estate. These estates are referred to as A and B trusts.
Understanding a Credit Shelter Trust (CST)
CSTs are established following the death of a married person and financed with that person’s full estate or a part of it, as specified in the trust agreement. These assets are subsequently transferred to the surviving spouse. However, since the trust is maintained by an appointed trustee, the surviving spouse never has access to the trust’s assets. As a result, the transfer does not increase the taxable estate of the surviving spouse.
One significant advantage of this sort of trust is that the surviving spouse retains certain rights to the trust assets for the rest of their lives. Under certain conditions, such as the need to support certain medical or educational needs, the surviving spouse may access the trust’s principal rather than only the income. When the surviving spouse dies, the trust’s assets are distributed to the remaining beneficiaries without regard for estate taxes.
CSTs are often referred to as AB Trusts or Bypass Trusts. This is due to the fact that CSTs are effectively bypass trusts in which each spouse has their own “taxable” estate. These estates are referred to as A and B trusts.
The key advantage of CSTs is that the surviving spouse may utilize the trust’s capital and income for medical or educational costs for the rest of their lives. The residual assets are subsequently passed on to the recipients without being liable to estate taxes.
Credit Shelter Trusts and Tax Protection
CSTs are intended to allow spouses to fully utilize estate tax exemptions. In 2021, the generation-skipping transfer tax (GSTT) exemption for individuals was $11.7 million and $23.4 million for couples. In 2020, it was 11.58 million (individual) and $23.16 million (couples).This will be in effect until December 31, 2025, unless Congress significantly updates the Tax Cuts and Jobs Act before then.
Benefits of a Credit Shelter Trust
The credit shelter trust offers benefits that go beyond inheritance tax planning. A CST protects a surviving spouse’s assets and allows for distribution flexibility.
The CST safeguards a surviving spouse’s assets. For example, the assets of a surviving husband are vulnerable to creditors and probable depletion by children or a new significant other. The CST protects the assets from creditors and from being improperly utilized by the surviving spouse, such as paying the debts of a new spouse or their kid.
Protecting the dead spouse’s testamentary intent: In a blended family, each spouse may wish to guarantee that their portion of the estate is given to their selected beneficiaries, such as children from a previous marriage, rather than solely to the surviving spouse’s beneficiaries. The CST can assist with this.
Flexible distribution provisions in the trust: The trust wording might include a limited power of appointment for the surviving spouse. As a result, the surviving spouse may divide the assets among a group of beneficiaries (for example, “the dead husband’s issue”). A kid who did not need a special needs trust when the trust was created, but when the decedent spouse died, a special needs trust was desired. In this situation, the surviving spouse might transfer the assets to a new special needs trust to benefit the kid.
Maximize the Deceased Spouse’s Generation-Skipping Tax (GST) Exemption
The GST exemption is not transferrable; however, the bypass trust may transfer the GST to a GST exempt bypass trust, keeping the GST exemption for lifelong children’s trusts.
Protecting asset growth from further estate tax on the death of the surviving spouse: On the death of the deceased spouse, a $5 million property or stock portfolio may be assigned to the CST. The surviving spouse may utilize the portfolio, which can grow to $8 million and then transfer tax-free to the bypass trust beneficiaries.
Property tax advantages A distribution from the CST to a child is considered a transfer from the deceased spouse rather than the surviving spouse. The distribution may take advantage of the departed spouse’s non-residence parent-child property tax reassessment exclusion of $1 million. Spouses who own significant rental or vacation homes may benefit from an extra $1 million in reappraisal exclusion.
Example of a Credit Shelter Trust
Assume a husband and wife who have been married for many years each collect an estate worth $6 million, and the husband establishes a credit shelter trust to be financed with his half of their combined inheritance upon his death. Because the husband’s estate is less than the federal exemption, his $6 million estate and any income produced by it pass to his wife free of estate tax.
The transfer, however, raises the wife’s net income to $12 million, exceeding the estate tax exemption. Because these assets are kept in trust and are not under the wife’s control, her taxable estate is still $6 million and falls under the estate tax exemption. As a result, when she dies, she may pass on her assets to her children without having to pay an estate tax.
How Do I Terminate a Credit Shelter Trust?
If one spouse dies while the remaining spouse is still living, the CST may be changed or terminated by the trustee alone, by the trustee and all of the beneficiaries, or by going to court. Beneficiaries’ consent is usually necessary.
What Happens When a Credit Shelter Trust Is Depleted?
In certain situations, the value of a first decedent’s gross estate may be decreased by deductions for debts, burial costs, and estate administration expenditures, and it may not be big enough to take full advantage of the estate tax exemption. In such case, the surviving spouse may keep the unused exemption provided the first decedent’s executors make a portability election on a promptly completed Form 706. (United States Estate [and Generation-Skipping Transfer] Tax Return).
What Is a Revocable Credit Shelter Trust?
The trust stipulations are placed in a will by the grantor, or the person who established the CST. The trust is revocable, which means that the grantor may amend the provisions at any moment throughout their lifetime. When the individual dies, the trust becomes irrevocable and assets, generally the remainder of the estate tax exemption, are transferred to it.
The trust’s assets may provide income to the surviving spouse. When the surviving spouse dies, the trust’s assets are tax-free to the beneficiaries. The trust relieves the heirs of the burden of unutilized inheritance tax exemptions.
Does a Credit Shelter Trust Have a Step-up Basis?
“Funding the credit shelter trust at the death of the first spouse gives a cost basis for those assets in the trust as of the date of death of the first spouse,” according to the law firm Rudman Winchell. However, since the assets in the credit shelter are not included in the taxable estate of the surviving spouse, there is no second step-up in basis upon the surviving spouse’s death.
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