How to Implement a Credit Shelter Trust

For couples facing a potential federal estate tax, a common estate-planning tool used to minimize this tax is known as a credit shelter trust. This type of trust is also referred to as a by-pass trust or an A-B trust. The purpose of this type of trust is to minimize the overall estate tax paid by the estates of the two spouses. To accomplish this goal, the trusts separate assets into various shares, including marital and credit shelter shares.

Potential Tax Consequences

When the first spouse dies, the successor trustee has important decisions to make. First, the trustee will have to make decisions as to which assets should be placed into the marital share and which assets should be placed in the credit shelter share. These decisions can have important estate and capital gains tax consequences.

Marital Trust

While the terms of these trusts may vary, generally, marital trust shares provide for the following:

  • Income from the trust is typically paid to the surviving spouse.
  • Trust principal is made available to the surviving spouse at the discretion of the trustee.
  • When the surviving spouse passes away, the remaining assets are added to the credit shelter share.

Credit Shelter Trust

Similarly, the credit shelter share is often implemented as follows:

  • Income from the trust is made payable to the surviving spouse as well as other potential beneficiaries.
  • Trust principal is typically not given to the surviving spouse, and if it is, it is a decision made by the trustee.
  • Since the surviving spouse does not have the ability to control these funds, they are not included in the surviving spouse’s estate when he dies. Instead, they are covered by the first spouse’s federal estate tax exemption amount.
  • After the surviving spouse passes away, the trust assets are distributed according to the terms of the trust.

Recently, spouses were given the option to preserve the first spouse’s exemption amount without using a credit shelter trust. This is referred to as portability. However, there are still many valid reasons to utilize these trusts.

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