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A credit shelter trust (CST) is a legal tool used by wealthy married couples to reduce estate taxes. When one spouse passes away, their portion of the couple's property, up to a certain amount, is put into an irrevocable trust that will pass to beneficiaries other than the surviving spouse. The surviving spouse's portion of the property and any leftover assets above the exclusion amount are put into a separate trust that they control. When the surviving spouse passes away, both trusts pass to their named beneficiaries. This method may save on estate taxes, but it can be costly and is only beneficial in limited circumstances.
A Credit Shelter Trust (CST), also known as an AB trust or a bypass trust, is a legal tool used by wealthy married couples to maximize their estate tax exemptions. This strategy involves creating two separate trusts after one spouse passes away.
Typically, the deceased spouse's portion of the couple's property, up to the applicable exclusion amount (currently $11.7 million), is placed into Trust B (the bypass trust). This trust is irrevocable and will pass to beneficiaries other than the surviving spouse, usually their children. The surviving spouse must follow the trust's plan without overly benefiting from its operation, but this trust often passes income to the surviving spouse to live on for the rest of their life.
The surviving spouse's portion of the property and sometimes the leftover assets of the deceased spouse above the exclusion amount will be put into Trust A. The surviving spouse has control over this trust and may use it as they wish. When the surviving spouse passes, both trusts pass to their named beneficiaries.
For example, John and Jane are a wealthy married couple. John passes away, and his portion of the couple's property, worth $10 million, is placed into Trust B. Jane's portion of the property, worth $5 million, is placed into Trust A. When Jane passes away, both trusts pass to their named beneficiaries.
This method of dividing assets may save on estate taxes, but only in limited circumstances. Before the Tax Cuts and Jobs Act, many individuals used this to take full advantage of their estate tax exclusions, which were less than $6 million. After the Tax Cuts and Jobs Act, this tool can only be beneficial in limited circumstances because the exclusion now is over $11 million, which applies to few individuals. However, many states have no gift taxes or have estate taxes that are not portable, which might make bypass trusts still beneficial to wealthy couples.
It is important to be careful when using bypass trusts and to seek advice from estate experts. The Internal Revenue Service (IRS) requires specific wording in the creation of these trusts and limits on the surviving spouse's use of the bypass trust. Also, given the high fees involved in planning, managing, and paying for attorney fees for bypass trusts, often a bypass trust may be more costly than the estate tax itself, and sometimes, the estate would incur less taxes outside of the bypass trust by incurring a stepped-up tax basis for property.