I have written before about life events which should prompt a review of ones will and trust. You can read the article here. One item I did not mention in that article which continues to be brought to my attention as I review estate plans are documents which contain an estate planning tool used quite often in previous years, called a “credit shelter” or “bypass” trust.
During the dot.com era in the 90’s, I drafted plenty of these trusts. In lieu of salaries, executives of dot.com start-ups were provided large life insurance policies and stock incentives. They were literally “worth more dead than alive”. Now however, with the passage of the American Taxpayer Relief Act of 2012, having a credit shelter trust may now be unnecessary and burdensome. If your estate plan includes one, it would be wise to, as soon as possible, have your documents reviewed and quite possibly updated.
The credit shelter trust was created as a strategy to avoid or reduce federal estate taxes. When I obtained my license to practice law in 1987, any estate value exceeding $600,000 was subject to a death tax rate of 50%. That is a huge tax, and of course most people found it objectionable. Attorneys for many years had a method to double the exemption to $1,200,000, saving a married couple up to $300,000 in federal estate taxes, plus additional savings at the state level. The idea was that when the first spouse died, that spouse would not leave all the assets outright to the surviving spouse. Instead, part of the estate was placed into a bypass or credit shelter trust in which the surviving spouse maintained an interest, but it was a limited interest. Therefore, it was subject to estate tax as the transfer was not to the surviving spouse but to a trust in which the surviving spouse has a limited interest and control. There would be no tax however as the transfer was under the exemption amount. The part of the estate which transferred directly to the surviving spouse was tax free due to the unlimited marital deduction provided if the surviving spouse was an American citizen. On the death of the second spouse, the funds in the credit shelter trust has already been subject to tax and the remaining estate would receive another $600,000 exemption upon death.
For several decades, that idea was embraced by many married couples whose estates exceeded the $600,000 exemption amount. Now, the exemption amount has reached $5.45 million which has eliminated the need for any estate below $5.45 million to have a bypass trust in order to avoid estate taxes. In fact, the idea of doubling the exemption for both spouses has now become part of federal law, so up to $10.9 million can pass free of estate taxes without the need for a bypass trust at all. This new legal strategy is called “portability,” which allows the unused exemption amount of the first spouse to die to be preserved for use by the second spouse to die.
With a credit shelter trust, the surviving spouse does not have complete control over the assets in the trust. The surviving spouse’s right to use assets in the credit shelter trust is limited and requires the filing of a separate tax return. Also, if the credit shelter trust is created as part of a will (as opposed to being drafted as part of a revocable living trust), the trustee of the credit shelter trust will have to file detailed and tedious annual accountings with the court for the remaining lifetime of the surviving spouse.
Credit Shelter trusts generally require that the maximum amount be transferred into the trust when the first spouse dies. Today, that would be $5.45 million, in most cases, all the money in the deceased spouse’s estate.
Even though the tax motive for the credit shelter trust is gone in most cases, this trust still exists in many estate plans and may be an outdated ticking time bomb ready to go off upon the death of the first spouse. For most married couples, it is unnecessary, burdensome, and expensive. This is why many couples should modify their estate planning documents to eliminate the credit shelter trust, because it won’t go away on its own. If you leave it in place, instead of saving money, it could add time, expense, and burden to the administration of your estates. On the other hand, some estates may benefit by keeping the credit shelter trust in place but perhaps modified to meet the present needs of families. Again, as I state repeatedly, one size does not fit all and as I also tell clients, changes in the law which may affect estate plans should prompt a review of your documents.