The Credit Shelter Trust, sometimes referred to as a “Bypass” or “AB” trust, is so important to any married person’s basic estate plan that it would be malpractice for any estate planner not to at least discuss this estate tax saving tool with his or her married clients. This trust, properly drafted and implemented, will insure that a spouse’s exemption from the federal estate tax will not be wasted.
By way of background, every U.S. citizen and most U.S. residents are granted a lifetime exemption from the federal estate tax. Although technically a credit, the amount of this credit exempts the first $3,500,000 of any one individual’s estate from taxation in 2009. Although future legislation is expected, the current law would exempt only $1,000,000 per person from taxation in 2011. In addition to one’s lifetime exemption,
gifts or inheritances to spouses are fully exempt from estate taxation.
A couple with a combined taxable estate of less than two times the applicable exemption ($7million in 2009, but $2million in 2011) would expect that their ultimate beneficiaries (usually their children) would pay no federal estate tax. Under current law though, this is not always the case. Assume Husband and Wife each have a taxable estate of $1million or a total of $2million. Husband dies in 2011 when the exemption is $1million. Husband leaves his entire estate to Wife and because of the unlimited marital deduction, no estate tax is due. Wife dies then with an estate of $2million. Since her estate has an exemption of only $1million, her beneficiaries are subject to a federal estate tax of approximately $500,000 ($1,000,000 taxable estate times 50% federal estate tax rate).
This happened because her husband wasted his exemption by leaving his entire estate to his wife. This could have been avoided by leaving an amount of his estate equal to the exemption to the couples’ ultimate beneficiaries, but for a lot of reasons this is not usually practical. The solution then is for the first spouse to die to leave the amount of the exemption to a credit shelter trust. The taxable estate of the second to die spouse then would not include this amount.
The language contained in a properly drafted Credit Shelter Trust is by necessity voluminous and complex. However, the trust is fairly simple to administer. In order to accomplish the goal of not wasting the first-to-die spouse’s exemption, the principal (generally up to the amount of the exemption) is left to the couple’s ultimate beneficiaries, for example the children. Typically they are not entitled to any of the principal until the second spouse passes away. The surviving spouse receives all of the income from the assets placed in this trust during his or her lifetime. The surviving spouse may also receive the greater of 5% of the assets or $5,000 each year. In addition, the trustee is usually granted the authority to make discretionary distributions of principal to the surviving spouse for his or her health, maintenance, support or education. The surviving spouse is almost always a co-trustee and under certain circumstances, the only trustee.
Practically, the spouse has almost complete access to the assets of the trust. Considering that it comes with a substantial tax benefit to the ultimate heirs, it does seem foolish not to employ this tax saving tool where appropriate.
By way of background, every U.S. citizen and most U.S. residents are granted a lifetime exemption from the federal estate tax. Although technically a credit, the amount of this credit exempts the first $3,500,000 of any one individual’s estate from taxation in 2009. Although future legislation is expected, the current law would exempt only $1,000,000 per person from taxation in 2011. In addition to one’s lifetime exemption,
gifts or inheritances to spouses are fully exempt from estate taxation.
A couple with a combined taxable estate of less than two times the applicable exemption ($7million in 2009, but $2million in 2011) would expect that their ultimate beneficiaries (usually their children) would pay no federal estate tax. Under current law though, this is not always the case. Assume Husband and Wife each have a taxable estate of $1million or a total of $2million. Husband dies in 2011 when the exemption is $1million. Husband leaves his entire estate to Wife and because of the unlimited marital deduction, no estate tax is due. Wife dies then with an estate of $2million. Since her estate has an exemption of only $1million, her beneficiaries are subject to a federal estate tax of approximately $500,000 ($1,000,000 taxable estate times 50% federal estate tax rate).
This happened because her husband wasted his exemption by leaving his entire estate to his wife. This could have been avoided by leaving an amount of his estate equal to the exemption to the couples’ ultimate beneficiaries, but for a lot of reasons this is not usually practical. The solution then is for the first spouse to die to leave the amount of the exemption to a credit shelter trust. The taxable estate of the second to die spouse then would not include this amount.
The language contained in a properly drafted Credit Shelter Trust is by necessity voluminous and complex. However, the trust is fairly simple to administer. In order to accomplish the goal of not wasting the first-to-die spouse’s exemption, the principal (generally up to the amount of the exemption) is left to the couple’s ultimate beneficiaries, for example the children. Typically they are not entitled to any of the principal until the second spouse passes away. The surviving spouse receives all of the income from the assets placed in this trust during his or her lifetime. The surviving spouse may also receive the greater of 5% of the assets or $5,000 each year. In addition, the trustee is usually granted the authority to make discretionary distributions of principal to the surviving spouse for his or her health, maintenance, support or education. The surviving spouse is almost always a co-trustee and under certain circumstances, the only trustee.
Practically, the spouse has almost complete access to the assets of the trust. Considering that it comes with a substantial tax benefit to the ultimate heirs, it does seem foolish not to employ this tax saving tool where appropriate.
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