Special Alert to Existing Clients and Potential Clients

The Credit Shelter Trust was created as a strategy to avoid or reduce Federal Estate Taxes. By way of history, when I started practicing law in 1987, any estate value exceeding $600,000 was subject to Federal Estate Tax at a 50% rate, plus a State-level Estate Tax in most states. That is a huge tax, and of course most people found it objectionable.

Attorneys for many years had a method to double the exemption to $1,200,000, saving a married couple up to $300,000 in Federal Estate Taxes, plus additional savings at the state level. The idea was that when the first spouse died, that spouse’s Will did NOT leave all the assets outright to the surviving spouse. Instead, part of the estate was placed into a Bypass Trust — hey trust in which the surviving spouse maintained an interest, but it was a limited interest. The transfer to the Bypass Trust was not a taxable event because of the unlimited marital deduction between spouses, which allows an unlimited amount to be transferred to a spouse, or to a trust for the benefit of the spouse, so long as that spouse is an American citizen, without incurring any estate tax. On the death of the second spouse, the funds in the Bypass Trust could then pass free of estate taxes so long as that amount was less than $600,000, because the surviving spouse was entitled to an additional $600,000 exemption upon death.

For several decades, that idea was embraced by many married couples whose estates exceeded the $600,000 exemption amount. But in the year 2001, the exemption was raised by a change to Federal Law to $1 million and continued to grow to $3.5 million in 2009. Now, the exemption amount has reached $5.45 million – which has eliminated the need for any estate below $5.45 million to have a Bypass Trust. In fact, the idea of doubling the exemption for both spouses has now become part of Federal law, so up to $10.9 million can pass free of estate taxes without the need for a bypass trust at all. This new legal strategy is called “portability,” which allows the unused exemption amount of the first spouse to die to be preserved for use by the second spouse to die.

Besides being unnecessary, the following are problems with Credit Shelter Trusts, and why clients should generally have them removed:

1. With a Credit Shelter Trust, the surviving spouse does not have complete control over the assets in the trust. The surviving spouse’s right to use assets in the Credit Shelter Trust is limited and requires the filing of a separate tax return. Worse yet, if the Credit Shelter Trust is created as part of a Last Will and Testament (as opposed to being drafted as part of a Revocable Living Trust), the trustee of the Credit Shelter Trust will have to file detailed and tedious annual accountings with the court for the remaining lifetime of the surviving spouse.

2. Credit Shelter Trusts generally require that the maximum amount be transferred into the trust when the first spouse dies.

Even though the tax motive for the Credit Shelter Trust is gone, for many clients with all their documents, the Trust still exists as an outdated ticking time bomb ready to go off upon the death of the first spouse. For most married couples, it is unnecessary, burdensome, and expensive. This is why many couples need to modify their estate planning documents to eliminate the Credit Shelter Trust, because it won’t go away on its own. If you leave it in place, instead of saving money, it will add time, expense, and burden to the administration of your estates.

The only time a Credit Shelter Trust should still be used is if your estate is greater than the current estate tax exemption of $10.9 million, or in some cases when spouses are worried about the surviving spouse possibly getting remarried and/or changing trust beneficiaries after the death of the first spouse. If your estate plan contains an unnecessary Credit Shelter Trust, please call my office immediately to make an appointment to update your estate planning documents. If you’re not sure if your trust has this language, please read through the trust(s) to see if you see the phrase “credit shelter trust” or “family trust” or “bypass trust.” If you are a client or former client of our firm, you might also be able to look at the cover page to the trust, where the very first line will indicate the type of trust. If it says AB trust or ABC trust, then you need to come in to talk about updating your planning, as the “B” stands for Bypass.

Even if your estate planning documents do not contain a Bypass Trust, they should still be updated regularly. Just as a car needs regular maintenance, your estate planning documents need to be updated or redone regularly, especially if it has been more than 5 years since you have done so. This is the only way to ensure that your estate plan truly reflects who you are, what you care about, and what you have.

So, when are updates needed? The list below pinpoints certain examples of events that could have a significant impact on your estate.

• You get married or divorced

• Your spouse dies or becomes incapacitated

• You become ill or disabled

• You have a new child

• Your child marries or divorces

• Your child becomes ill or disabled

• You have a new grandchild

• One of your beneficiaries shows signs of being financially irresponsible

• One of your beneficiaries develops a drug or alcohol problem

• The value of your assets has significantly increased or decreased

• You retire or change employment

• You acquire property in a different state

• You move to a different state

• There have been changes in the law that may affect the language of your documents.

Fairfax Estate Planning: 703-691-1888
Fredericksburg Estate Planning: 540-479-1435
Rockville Estate Planning: 301-519-8041
DC Estate Planning: 202-587-2797