What is a Credit Shelter Trust?

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A CST (credit shelter trust) is a trust established following the death of a married couple’s first spouse. Assets deposited in the trust are normally kept separate from the surviving spouse’s estate, allowing them to transfer tax-free to the remaining beneficiaries upon the surviving spouse’s death. The surviving spouse may benefit from the assets in the CST throughout their lifetime.

How do they function?

CSTs may be utilized in combination with the unlimited marital deduction since transfers to surviving spouses are normally free of the federal estate tax. If the executor or trustee is ordered to completely fund the CST upon death, assets equal to the deceased spouse’s eligible lifetime federal gift and estate tax-relevant exclusion amount would be transferred to a CST for the surviving spouse’s lifetime benefit. The trust assets will transfer tax-free to the CST beneficiaries when the surviving spouse dies. The credit shelter trust protects the assets, as well as any growth in their worth, from being included in the surviving spouse’s estate.

To get the most out of the federal estate tax, each spouse should have enough assets in their own name such that the value of each spouse’s assets matches (or exceeds) the appropriate exclusion threshold.

Portability vs. CST

The Internal Revenue Code allows the surviving spouse to transfer the unused relevant exclusion amount of the first-to-die spouse to the surviving spouse, who may then utilize it for a gift or estate tax reasons. Although depending on portability may be more convenient than developing and running a CST, the latter offers various advantages:

At the passing of the surviving spouse, any appreciation in the value of the assets in the CST skips the surviving spouse’s estate and is not subject to federal and/or state estate taxes.

State estate tax exclusions (for states that impose a state estate tax) and the federal generation-skipping transfer tax exclusion are typically not portable. As a result, any unused state estate tax exclusion and generation-skipping transfer tax exclusion of the first spouse to die would be forfeited if a CST is not utilized.

Assets held in a trust are normally safeguarded from creditors of the recipient.

Rather than depending on the surviving spouse to carry out the desires of the first spouse to die, the first spouse to die may direct where the assets remaining in the trust are allocated following the surviving spouse’s death.

Considerations

Consider the following potential drawbacks of a credit shelter trust before talking with your attorney or tax advisor:

In order to get the advantages of a CST, the trust must submit income tax reports. If the assets used to support the trust are intricate, the filing process may be time-consuming and costly.

Unlike portability, where the tax basis of the assets is stepped up twice at the death of the second spouse, the tax basis of the assets in a CST is only stepped up once—at the death of the first spouse.

The surviving spouse must be ready to accept just a restricted set of rights and authority over the trust’s assets. In general, they have access to all of the trust’s revenue, and they may use the principle to pay for health, education, maintenance, and living costs as the trustee. If the trustee is not the surviving spouse, the trustee has the option to distribute trust assets to that spouse for other reasons.

The Tax Cuts and Jobs Act, 2017, likely had an influence on the assets that transfer to a CST. Due to the rise in the relevant exclusion level, the number of assets that would be more easily accessible to the surviving spouse may be decreased or eliminated if a CST is automatically financed.

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