If you are married and your combined estate exceeds the federal estate tax exemption, then a credit shelter trust could reduce your inheritance taxes. With a credit shelter trust, each spouse can use their full estate tax exemption, which could effectively double the exemption.
For example, consider a couple with $3,000,000 in total assets who wants to leave their property to each other if one should pass away. Upon the death of the first spouse, all property left to the surviving spouse passes tax-free. However, this leaves the surviving spouse's estate at $3,000,000. When the second spouse passes away, tax would have to be paid on the amount over the exemption ($1,000,000 taxed at a maximum marginal rate of 35% in 2007).
Who Benefits from a Credit Shelter Trust?
With a credit shelter trust, the beneficiaries of the trust are the deceased spouse's other heirs -- usually the children. This way, if $1,500,000 is placed in the credit shelter trust by the first spouse, then all of those assets can pass to the children tax-free. However, the surviving spouse still obtains a life estate in those assets, which means that the surviving spouse can use it during his or her lifetime. In addition, the surviving spouse will have full use of all income generated by the assets, and can even use the principal for heath and maintenance.
Upon the death of the second spouse, the remainder of the estate ($1,500,000) would fall below the exemption. Therefore, no tax would be owed.
LegalZoom's Credit Shelter Trust
Due to the uncertain future of the estate tax, LegalZoom's credit shelter trust is discretionary. In other words, the surviving spouse has the option to fund the credit shelter trust at the time the first spouse has passed away. Here's how it works: Under the IRS Code, the surviving spouse has the choice to disclaim, or reject, any property and assets left to him or her. All property that is disclaimed (up to the estate tax exemption limit) then would go to the credit shelter trust.
With a mandatory credit shelter trust, the inheritance would automatically be placed into the trust, and the surviving spouse would not have any discretion to make a decision based on the tax laws then in effect.
