Historically, clients used credit shelter trusts to ensure that the estate tax exemption of the first spouse to die was maximized, thus reducing the estate tax burden of the entire martial estate. Since today's statutory portability provisions, now made permanent, automatically allow a married couple to use their entire combined exemption ($10.5 million per couple in 2013), many clients assume the credit shelter trust is no longer a necessary planning tool.
For many clients, this is a misperception — all clients should be advised as to the non-tax benefits that can be realized, but for high-net-worth clients, the use of a credit shelter trust continues to present a viable strategy for substantial estate tax savings.
Credit shelter trust basics
Prior to the advent of portability, credit shelter trusts were essentially used by married couples to fully use their two estate tax exemptions. The deceased spouse's assets would be placed into a trust created for the benefit of the surviving spouse, using only the deceased spouse's exemption and keeping those assets out of the surviving spouse's estate.
For example, without portability, if a client died with $3 million in assets and passed those assets to his spouse, who also had $3 million in assets, the $3 million bequest would not be taxed at the federal level. Despite this, the surviving spouse would be left with $6 million in assets, so would possibly incur an estate tax bill upon her death without the use of a credit shelter trust.
Portability eliminated this problem by allowing a surviving spouse to automatically use his deceased spouse's exemption, eliminating one reason for the credit shelter trust. This view, however, may be overly simplistic in light of the many other benefits a credit shelter trust can provide.
Credit shelter trusts after portability
First, it is important to note that while a deceased spouse's exemption is portable, it also freezes at the time of that spouse's death. This is particularly important for your high-net-worth clients because if a couple relies on portability and a significant period of time elapses before the second spouse dies, he could miss out on significant savings.
Further, the value of the assets placed into the credit shelter trust is also frozen at the time of the first spouse's death. If the assets placed into the trust are valued at $4 million at the time of the first spouse's death and double in value before the second spouse dies 10 years later, the entire $8 million will be excluded from the surviving spouse's estate even if the exemption level has not yet reached that level.
The client should also be aware of estate or inheritance tax provisions at the state level. Because portability at the state level has yet to emerge, the use of a credit shelter trust may remain relevant for clients seeking to avoid state death taxes.
