A. Overview. The stand by credit shelter trust is an estate planning tool that allows for the maximum use of the exemption equivalent amount ($1,000,000.00 in 2011 and succeeding years) for each spouse, thereby potentially doubling the amount that can pass to children (or other non spousal beneficiaries), federal estate tax free.
B. Example without a credit shelter trust. Assume husband and wife, together, have $2,000,000.00 in assets, with $1,000,000.00 owned separately by each. Assume husband dies first and his Will provides that his estate passes to his wife. Assume wife dies shortly after husband with a Will that distributes her estate (now $2,000,000.00) to the children. Wife’s net taxable estate above $1,000,000.00 is subject to the federal estate tax at rates that begin at approximately 37%.
C. Example with a credit shelter trust. Assume the same $2,000,000.00 of total assets. This time, when husband dies, his separate $1,000,000.00 of assets do not pass outright to his wife; instead, she elects to have that amount pass to a credit shelter trust for her benefit. When she dies, her separate estate of $1,000,000.00 passes estate tax free to the children. In addition to that, the $1,000,000.00 in the credit shelter trust also passes estate tax free to the children. If the $1,000,000.00 in the credit shelter trust has grown over the years to $2,000,000.00, the entire $2,000,000.00 passes estate tax free to the children.
D. How does the credit shelter trust work? The surviving spouse is the sole beneficiary or the primary beneficiary. Income and principal can be distributed to the spouse during her/his lifetime. An independent trustee, however, must control the decision about discretionary distributions of income or principal to the surviving spouse. It is because the independent trustee is in charge of the discretionary distributions of income or principal that the assets in the trust are not considered “owned” by the surviving spouse at her/his death. The independent trustee can be a family member. The surviving spouse can have a limited power to remove and replace the trustee if dissatisfied with the trustee’s performance.
E. Why is it stand by? Since there may be no need for a credit shelter trust when one spouse dies, the trust is a stand by trust. That means the surviving spouse decides whether to activate the trust by funding it after a spouse’s death, but the surviving spouse need not make that decision until after a spouse has died. For that reason, the decision about whether to activate the trust will be based upon the financial circumstances and state of the law that exist at that time, not at the time the Wills are signed. This creates a significant degree of flexibility.
It is always important to create as much flexibility as possible in an estate plan. Probably, no one would opt for a credit shelter trust were it not for the tax reason that motivates the choice. The federal estate tax is a hot political issue. There are proposals to increase the exemption equivalent amount above $1,000,000.00, and there also are proposals to eliminate the federal estate tax entirely.