Credit Shelter Trust: What It Is and Why You Might Need It

Could your loved ones use an extra $100,000?

Creating a credit shelter trust could be one way to keep more money in your estate rather than losing it to estate taxes. Credit shelter trusts are related to marital deduction and estate tax laws. Here in Massachusetts, an estate worth less than $1 million is not subject to estate tax. Massachusetts doesn’t recognize portability, which means that one spouse’s exemption doesn’t transfer to the surviving spouse. Because of the marital deduction, the assets of the first spouse to die are passed to the surviving spouse and aren’t subject to estate tax. The surviving spouse’s estate may be taxed when he or she dies.

Let’s say spouse A dies with an estate valued at $500,000. His assets are transferred to spouse B, who doesn’t have to pay any estate tax. She wouldn’t anyway, because the estate is worth less than the $1 million exemption mark. But even if the estate was worth more than $1 million, she wouldn’t have to pay the tax because of the marital deduction.

Now let’s say that, when spouse B dies, her estate is worth $3 million. That includes all of spouse A’s assets, which were transferred to her. He didn’t use his estate tax exemption because his estate was valued at $500,000. In some states, his unused exemption would roll over to her. Because Massachusetts doesn’t have portability, that’s not the case.

In any case, spouse B’s estate will ultimately be left to a child, other relative, friend or other trusted party. That estate, which will probably include both partners’ assets, will be subject to taxes if it’s valued at more than $1 million. Creating a credit shelter trust is one way to minimize the estate’s tax liability and maximize the marital deduction.

Establishing credit shelter trusts allows a married couple to take advantage of their individual tax exemptions. Each spouse creates his or her own trust, funded by his or her individual assets. When spouse A dies, $1 million will remain in his credit shelter trust. Anything extra will flow into a marital sub-trust, which spouse B can access and use – but those assets don’t become hers outright, and she doesn’t control them. Technically, the assets held in the trust are separate from spouse B’s estate and so they aren’t counted toward her estate. If her estate has a value below the Massachusetts threshold of $1 million, it doesn’t matter how much is in spouse A’s estate. Its value won’t determine her estate’s taxable status.

When spouse B dies, her estate will also fund the credit shelter trust with $1 million. Whatever’s left is what’s taxable. If she had $1.9 million in her estate before death, $1 million would be sheltered and the remaining $900,000 would be below the exemption threshold.

In Massachusetts, each spouse can fund the credit shelter trust with $1 million. The couple can shelter $2 million this way. That’s double the amount that they would be able to shelter without the trust, which represents tens of thousands of dollars in tax savings.

Could a credit shelter trust help your loved ones to keep more of your estate? Contact Ladimer Law to find out.