Credit shelter trusts have been a very popular part of estate planning for decades. While recent changes have greatly reduced the need for this planning technique it is important for estate planners to understand this technique because it is still often found in documents which may be in place for clients. In addition, there are states which maintain lower state estate tax exemptions despite increases at the federal level. If clients live or own property in other states it may still be necessary to utilize this planning technique to obtain the most favorable tax result for such clients. The name credit shelter trust is derived from the process which takes place at the death of the first spouse and how the available tax credits offset potential federal estate taxes to minimize the overall estate tax liability of a married couple. In essence, the estate of the first spouse to die is divided into two portions of which one part is distributed to a trust for beneficiaries, typically children, with some limited rights provided to the surviving spouse for use during their lifetime. The second part is distributed into another trust which holds property for the surviving spouse and can be used for anything the surviving spouse chooses. The trust under this type of planning strategy referred to using several different terms but the results are typically the same.
This type of planning is often referred to generally as A–B trust planning because it is made up of two separate trusts which serve different purposes. Trust A is commonly referred to as the marital trust, QTIP trust, or marital deduction trust while Trust B is referred to as the credit shelter trust, bypass trust, or family trust. Ultimately the goal is to avoid wasting any tax credits or exemptions that may be available to a married couple when the first spouse passes. One trust, set up by your Montgomery County estate lawyer, known typically as Trust B, is funded with an amount up to the maximum unified credit the first to die spouse has available at the time of death parentheses or more commonly the state death tax exemption amount in today's text climate and premise.
The other trust, Trust A, will receive the remaining assets so the spouse can use them however they see fit and then will pass the assets to beneficiaries when they die as part of their own estate. While this formulaic estate and tax planning approach is designed to maximize benefits under the state tax rules, significant changes to the estate tax laws over the last few years have significantly impacted this planning technique. A more detailed explanation with examples on how the distributions are made is outlined when you discuss specific marital deduction trusts, but is important to note that this planning technique remains a viable option for states to apply state estate taxes to estates valued far below the federal exemption levels and do not allow portability of their exemptions between spouses.
Specifically, New York and New Jersey have maintained lower state tax exemptions without portability provisions have just $1 million and $675,000 respectively. If clients live or own property, especially vacation properties which are popular for residents of Pennsylvania, it may be beneficial to implement these techniques. In 2010 the federal estate tax rules were changed to allow up to $5 million to pass free of federal estate tax to decedent’s beneficiaries. This amount is also tied to inflation so in 2013 a person can exempt up to $5.25 million per person from federal estate tax using the available unused credit. In addition, a portability provision was added allowing a surviving spouse to use any or all of a spouse's exemption that was not used at the first death to pass a total of $10.5 million to beneficiaries without federal estate tax in 2013. Due to these changes it is also important for estate planners to recognize formula based A–B trust planning that may be present in client’s current documents to ensure their needs are still being met. While many individuals may have met the $1 million exemption and require this planning a decade or so ago, a formula requiring the first $5.25 million to be deposited into credit shelter trust for beneficiaries may have the unintended result of leaving little or nothing for the surviving spouse out right. For this reason it is important to understand and discuss these planning techniques with clients to ensure their state planning is properly reflected with their intentions and stated goals.