Credit Shelter Trust
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Used correctly, a credit-shelter trust can double the amount you and your spouse leave to your children free of federal estate taxes. Here is an example based on the $2.5 million exemption amount allowed in 2007. Suppose you leave your entire $5.0 million estate outright to your spouse. After your death, your estate incurs no federal estate taxes because of the marital deduction. But upon the death of your spouse in 2007, only half of the estate ($2.5 million) is exempt. Your children will pay up to $1,125,000 of federal estate taxes on the other half. That's poor planning.
Instead, suppose you willed only $2.5 million to your spouse outright, and put the other $2.5 million in a credit-shelter trust. Your spouse would be entitled to income from the trust after your death. But after the death of your spouse, the assets in the trust won't be part of your spouse's estate, so they'll also pass tax-free to your children. And the other $2.5 million is also untaxed due to your spouse's own $2.5 million exemption. Assuming no appreciation or depreciation of the assets’ values, your children inherit $5.0 million free of estate tax.
To ensure that your children will enjoy these savings, your spouse should have a credit shelter trust in his or her estate plan. Also, each spouse should have assets valued at the exemption equivalent amount in his or her own separate name to leave to those trusts.
A word of caution: to maximize the advantages provided by the tax law, a review of your will, trusts and any other estate planning documents is in order. As the new exemption limits go into effect, wills that mention $1.0 or $1.5 million figure, for example, may need to be rewritten, and individuals who have carefully divided their assets so that each spouse has at least $2.5 million in assets may have to adjust their holdings. The increase in the exemption amounts means that, with proper planning, married couples who can exempt $5.0 million of assets today, could exempt $7.0 million as of 2009.
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