Estate Planning Alert - Credit Shelter Trust - Keep or Eliminate?


Married couples have long used "AB trusts" (marital/credit shelter trusts) to minimize estate taxes at the second death. However, now that the federal estate tax exemption is $5.25 million, is "portable" between spouses and is indexed, well under 1% of estates are expected to be subject to federal estate tax. Therefore, couples with such trusts need to re-assess the need for them by considering the factors discussed below, and couples considering establishing such trusts likewise need to consider these factors.

Even though a credit shelter trust will probably no longer save us estate taxes, is there any harm in keeping it? Maybe. Trust assets will need to be kept separate from the assets of the surviving spouse, and annual trust tax returns will be required, which could be annoying to a surviving spouse who would rather "keep it simple." Moreover, if the children are also current beneficiaries of the credit shelter trust, they will be entitled to an annual report of the trust unless they waive that right. Finally, any growth of trust assets between the first and second deaths will be subject to capital gains taxes if sold after the second death, since there is no basis step-up at the second death, as would be the case if the assets were includable in the surviving spouse's estate.

So there is no reason to keep a credit shelter trust if it probably won't save estate taxes? Not so fast! There are still reasons to consider keeping a credit shelter trust, including:

(i) sheltering growth of the assets between the two deaths from federal estate tax,

(ii) protecting the children's inheritance in the event of the remarriage of the surviving spouse (a significant concern for many couples)

(iii) creditor protection for the surviving spouse (especially important if the surviving spouse is in a high-risk profession, such as a physician)

(iv) the ability to shift trust income to family members who are in a lower tax bracket than the surviving spouse,

(v) assuring that the unused exemption of the first spouse to die will not be wasted, and

(vi) the ability to double the GST (generation-skipping transfer) exemption.

Therefore, while the choice of an AB trust was formerly nearly automatic for many financially successful couples, that decision is now more difficult and requires careful consideration of a number of tax and non-tax factors.

If you have any questions in regards to AB trusts, please contact an estate planning attorney at Eastman & Smith.