Could a credit shelter trust help you preserve wealth to pass on to your loved ones? It’s possible. In basic terms, a credit shelter trust is a type of trust used by married couples to minimize estate tax liability and preserve assets for their descendants. In states with high estate tax thresholds, this type of trust is used primarily by wealthy couples. Here in Massachusetts, where our estate tax threshold is significantly lower than the federal threshold, credit shelter trusts may also be useful for couples with more modest assets.
Why You Might Want a Credit Shelter Trust in Massachusetts
As you may know, an individual’s estate tax obligations depend on the value of the person’s estate at the time of their death. An estate that’s worth less than the current estate tax threshold is exempt from paying this tax. Each individual is allowed the same estate tax exemption amount, so married couples can collectively shield twice the threshold amount from estate taxes. Married couples may also take advantage of the marital deduction, a provision in tax law that allows one spouse to pass assets to the other spouse without incurring estate taxes.
The federal estate tax threshold is $11.4 million per individual in 2019, allowing a married couple to shield up to $22.8 million in assets from estate taxes. But states can establish their own thresholds. In Massachusetts, an individual’s estate is subject to the estate tax if it’s worth more than $1 million. That means that even families who are not ultra-wealthy may be required to pay estate taxes. If a decedent’s estate includes a home or life insurance, its value is likely enough to push the estate past the $1 million threshold.
Say that here in Massachusetts, a husband dies with an estate valued at $1.5 million. The marital deduction means that his assets are passed to his surviving wife and she doesn’t have to pay estate taxes, even though his estate is valued above the threshold. When the wife dies, her estate is worth $3.1 million, including the husband’s $1.5 million. Now her heirs have to pay estate taxes on $2.1 million, the entire amount that exceeds the $1 million threshold.
The couple was only able to shelter a total of $1 million from estate taxes. If they had capitalized on both of their individual exemptions, they could have sheltered a total of $2 million, allowing their beneficiaries to keep more of their money instead of losing it to estate taxes. Enter: credit shelter trusts.
How a Credit Shelter Trust Works
Using credit shelter trusts allows a married couple to take full advantage of their individual exemptions. Each member of the couple creates their own trust. When the first spouse dies, his trust is funded with his assets up to the amount allowed by the exemption. So in Massachusetts, his trust could be funded with up to $1 million. The marital deduction allows his assets to pass to his surviving spouse without incurring estate taxes. The money held in the trust can be accessed by his surviving spouse, but because she doesn’t control that money, it doesn’t count toward her estate. She may also create a trust that, when she dies, is funded with an amount not greater than the exemption amount. Her named beneficiaries can access the money but it’s not part of her estate and so isn’t taxed.
Take the above example. If each spouse had a credit shelter trust, their heirs would likely have owed much less in estate taxes. When the husband died, his credit shelter trust would hold $1 million, the total amount of his estate tax exemption. Depending on how the trust was set up, his spouse could access that money, but it wouldn’t become part of her estate.
Upon her death, her credit shelter trust would also hold $1 million, her personal exemption amount. The husband’s assets never passed directly into her control, so they’re not counted as part of her estate, and each spouse was able to shelter $1 million from estate taxes. The wife’s assets, which include the money left by her husband, now pass to her beneficiaries.
Sound complicated? It can be! Exactly how this plays out depends on which spouse dies first and what assets they have at the time of death. Couples must also meet certain conditions to be able to use credit shelter trusts. But if credit shelter trusts make sense for your circumstances, they can save your loved ones thousands and thousands of dollars in estate taxes.
At Ladimer Law, we welcome your questions about credit shelter trusts, and other strategies that can be used to protect your assets. How can Ladimer Law help with your estate planning? Contact us today!
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Ladimer Law specializes in estate planning. We protect our clients, their heirs, and their assets by listening closely, knowing the law, and executing estate plans that fit and evolve.