How to Double Your Estate Tax Exclusion by Using a Credit Shelter Trust

For 2011 and 2012, the federal estate tax exclusion is $5 million.  For taxable estates in excess of $5 million, the highest federal tax rate is 35%.  If there are no changes to the law, the federal estate tax exclusion will decline back to $1 million in 2013 and the highest federal estate tax bracket will be 55%.

Credit Shelter Trust
For married couples, there is a way they can double their federal estate tax exclusion by forming what's called a Credit Shelter Trust.  In 2011, this trust can be formed and funded up to the federal estate tax exclusion amount of $5 million.  So if each spouse funds a trust, up to $10 million can be sheltered from federal estate taxes.  Keep in mind that there is no federal estate tax on the passing of the first spouse.  This is known as the marital deduction.

Assets can pass from the deceased spouse to the surviving spouse with no federal estate taxes due.  However, if a Credit Shelter Trust was not used, the $5 million maximum federal estate tax exclusion will not be used upon the first spouse’s death.  A Credit Shelter Trust can be set up to have either mandatory or discretionary distributions.  Customarily, the income is distributed to the surviving spouse.  Distributions of principal tend to be discretionary.  Upon the passing of the surviving spouse, any assets remaining in the trust are distributed to the beneficiaries, usually children and grandchildren. 

Portability Rule
For 2011 and 2012, there is an option to use the so-called portability rule.  This essentially allows a surviving spouse to use any federal estate tax exclusion that was not used by their spouse.  While this may seem like a very taxpayer friendly rule, be cautious.  This portability rule is only in effect for 2011 and 2012.  Unless there is a change in the law, it makes it very difficult to plan with it only being in existence for these two years.

State Considerations
Taxpayers need to be cautious with their estate planning.  It used to be that most of the state estate tax exclusions were the same as the federal estate tax exclusions.  This is no longer the case.  For example, in Connecticut, the estate tax exclusion was $3.5 million.  Recent legislation has reduced this to $2 million retroactive to the beginning of 2011.  This may cause some people who are not subject to federal estate tax to be subject to state estate tax.

ACTION ITEM:  Married couples should consult with their estate planning attorney and CPA to review whether a Credit Shelter Trust is an appropriate part of their estate plan.

Thomas F. Scanlon, CPA, CFP®

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