All transfers between spouses during life or by bequest (except for those that convey less than full ownership—so-called terminable property interests) can be made free of federal transfer taxes. But estate owners were often cautioned that by taking full advantage of the marital deduction a deceased spouse would end up forfeiting his or her unused exclusion. Consequently, all of the couple’s assets minus the surviving spouse’s exclusion could then be subject to federal estate tax at the death of the second spouse.
To obviate this problem married couples employed a “credit shelter trust” (CST) in their estate plans. This credit shelter trust was purposefully designed so that it did not qualify for the marital deduction by giving the spouse less than full ownership in the transferred assets. This then enabled the first spouse to apply his or her exclusion against the value of the credit shelter trust. The rest of the estate passed to the survivor tax-free under the marital deduction. At the surviving spouse’s later death, assets in the CST were not subject to federal estate tax because the surviving spouse was not considered the owner for transfer-tax purposes. Then the survivor’s estate could use his or her own estate-tax exclusion to eliminate or reduce tax on the balance of the estate. The credit shelter trust enabled both spouses to fully use their federal transfer-tax exclusions.
Now, under the 2010 tax act, any unused exclusion remaining at the death of the first spouse may be added to the survivor’s own exclusion. The exclusion is not forfeited and the result of this portability effectively allows a married couple to pass up to $10 million to their heirs free of federal estate tax without the need of further planning.
Should you still consider a credit shelter trust?
For purely tax-planning purposes, the CST has lost most of its noted luster for estates worth less than $10 million. However, there are a number of reasons why a CST can and should be an integral part of a well-designed estate plan.
- Assets go to intended beneficiaries – With a CST you can protect your chosen beneficiaries. For example, if your spouse remarries, your children will benefit from the trust regardless of what might happen between your children and the new stepparent.
- Professional management – As with any trust, competent professional management of trust assets can help preserve more of your estate for your heirs, particularly if your surviving spouse lacks the interest or ability to manage the investments.
- Creditor protection – Assets placed in trust can be protected from the reach of your heirs’ creditors.
- Unused exemption not indexed for inflation – While the exclusion amount of $5 million is currently scheduled to be indexed for inflation, any unused exclusion remaining after the death of the first spouse will not benefit from indexing.
- Future estate appreciation – Although your estate may not currently exceed the exclusion threshold, future appreciation or perhaps inheritance could push your estate over the exclusion limit. Assets that appreciate in a CST will not be subject to federal transfer taxes following the surviving spouse’s death.
Planning note: The most recent changes to the federal estate tax are set to expire at the end of 2012 unless Congress acts to extend, repeal, or change them again. Relying on the portability benefit until there is some indication that it will become permanent could be premature. We urge you to get in touch with your financial and legal advisors to see how these latest federal estate rules will affect your current financial, estate, and philanthropic plans.