Legal Definitions - credit shelter trust

A Credit Shelter Trust (CST), also known as an AB trust or a bypass trust, is a sophisticated estate planning tool primarily used by married couples with significant assets to minimize potential estate taxes.

Here’s how it generally works:

• When the first spouse passes away, their will or trust directs a portion of their assets, typically up to the available estate tax exemption amount, into a special, irrevocable trust called Trust B (the bypass or credit shelter trust).
• The surviving spouse usually has access to the income generated by Trust B for their lifetime, ensuring their financial security. However, they do not own the principal assets in Trust B.
• Because the surviving spouse does not own the assets in Trust B, those assets are "sheltered" from being included in their own taxable estate when they eventually pass away. This means those assets bypass estate taxes a second time.
• The remaining assets, including the surviving spouse's own property and any of the deceased spouse's assets exceeding the amount placed in Trust B, are typically placed into Trust A. The surviving spouse has full control over Trust A.
• Upon the death of the surviving spouse, the assets in both Trust A and Trust B are distributed to the designated beneficiaries, often the couple's children or other heirs.

While historically a popular strategy for federal estate tax planning, changes in tax law (such as increased federal estate tax exemptions and the "portability" of a deceased spouse's exemption to the survivor) have made CSTs less universally necessary at the federal level. However, they can still be valuable in specific situations, such as:

• For couples living in states that impose their own estate taxes, especially if those states have lower exemption amounts or do not allow for portability.
• In blended families, where a spouse wants to ensure that their children from a previous marriage ultimately inherit specific assets, while still providing for their current spouse during their lifetime.

Due to the complexity and specific legal requirements involved, establishing a Credit Shelter Trust requires careful planning with an experienced estate attorney.

Examples:

• Blended Family Inheritance: Mark and Lisa are in a second marriage. Mark has two children from his first marriage, and Lisa has one. Mark wants to ensure his children ultimately inherit a significant portion of his wealth, but also wants Lisa to be financially secure for the rest of her life. Mark establishes a Credit Shelter Trust in his estate plan. When Mark passes away, a portion of his assets is directed into Trust B, with his children named as the ultimate beneficiaries. Lisa receives regular income from Trust B to support her, but she cannot spend the principal. When Lisa eventually passes, the remaining assets in Trust B go directly to Mark's children, bypassing Lisa's estate and ensuring his legacy for them while also providing for Lisa during her lifetime.

  This illustrates how a CST can protect assets for specific beneficiaries (Mark's children) while still providing for the surviving spouse (Lisa) without those assets being subject to estate tax again in the surviving spouse's estate.

• State Estate Tax Planning: David and Emily live in a state with a relatively low state estate tax exemption that is not portable between spouses. Their combined assets significantly exceed this state exemption. To minimize state estate taxes, they establish a Credit Shelter Trust. When David passes away, assets up to the state's exemption amount are placed into Trust B. Emily receives income from Trust B for her lifetime. Because these assets are held in Trust B and not owned by Emily, they are not counted as part of Emily's estate when she eventually dies, thus avoiding state estate tax on those specific assets a second time. This strategy effectively uses David's state estate tax exemption to shelter assets for their children.

  This example demonstrates how a CST can be particularly useful for navigating state-specific estate taxes, especially when state exemptions are lower or portability rules differ from federal ones.