Standard AB Trusts and Credit Shelter Trusts have the same purpose; they reduce federal and state taxes on married couples by removing assets from a taxable estate. Each method creates trusts to take maximum advantage of exemptions from federal and state estate taxes. Many estate-planning informational presentations refer to AB Trusts and Credit Shelter Trusts interchangeably. However, there are differences that indicate greater advantages from Credit Shelter Trusts in many situations.
Primary Benefit of a Trust
A primary benefit of a trust is the legal effect of removing trust assets from the taxable estate of the grantor. The grantor may terminate a revocable trust at any time during his or her life. The time of the grantor’s death fixes the trust. An irrevocable trust removes assets from the grantor’s estate upon execution of the trust documents. The grantor's death is the event that initiates actions with respect to trust property, such as distribution of assets or benefits.
Estate Planning with an AB Trust
A standard AB Trust involves creating two trusts. The first, or A Trust, contains assets of both spouses, and, created upon the death of one spouse, a second trust to hold assets of the deceased spouse, the B trust. In a standard AB Trust, the surviving spouse controls the assets and can be the named trustee.
The terms of the resulting trust are rigid, particularly with respect to successor trustees and the named residual beneficiaries. With the changes in federal estate law that permit portability of the spousal exemption, use of the AB Trust method declined significantly. There was no longer a demonstrable need to combine assets in an AB Trust.
Estate Planning with a Credit Shelter Trust
Using portability, one could transfer the unused portion of the deceased spouse exemption to the surviving spouse. However, the surviving spouse's estate might exceed the threshold limit for a single spouse. Assets held in a Credit Shelter Trust are not part of the taxable estate of the surviving spouse and thus shelters the exemption of the first spouse for use by the second spouse. This device grants full use of the entire estate without further tax liability and an ultimate transfer of assets and earnings to the intended beneficiaries.
The 2013 federal exemption is $5.25 million per spouse and a combined exemption of $10.50 million. If one spouse dies, then it may leave the surviving spouse with an estate that is higher than the federal or state exemption for one person and subject to substantial taxation. In effect, one loses the exemption provided for the first spouse; the survivor's estate would not have the benefits of two exemptions.
Planning in State with Estate Taxes
Some states have estate taxes, lower thresholds, and do not permit portability. For example, one can examine the situation of a married couple who lived in a state with a $2 million threshold on estates. A surviving spouse could face no tax liability for the value in excess of the federal threshold but have a significant liability under the state estate tax law.
The solution is to divide the total estate amount in excess of the state threshold of $2 million by two; this sum will be the trust amount. Then, one can create, in the trust amount, Credit Shelter Trusts in the names of each spouse. These trusts will contain the value of the estate in excess of $2 million. Upon the death of one spouse, the assets of his or her trust would provide income and benefits for the survivor. The Credit Shelter Trust would provide a similar benefit under federal estate tax laws if the estate exceeded the federal threshold.
Conclusion
There are some substantial advantages of Credit Shelter Trust over traditional AB Trusts. The primary advantage is full estate tax exemption under federal law. The assets transferred to the credit shelter trust are exempt from the grantor and surviving spouse's creditors. The surviving spouse never takes ownership of the assets in the Credit Shelter Trust. Taxes on trust assets are not chargeable to the survivor’s estate. The surviving spouse can enjoy full use of the assets, including cash payouts, funds for maintenance, healthcare and education.
Another extremely useful feature is the ability to name professional management to carry out the terms of trust and manage assets. The basic concern of many grantors is to ensure the financial well-being of a surviving spouse and descendants. There are often considerations of age, ability and experience when selecting a person to manage assets. The Credit Shelter Trust is a form that lends itself well to professional appointments. In this form of trust, the surviving spouse has rights to demand payment from interest, profits, or principle for expenses and contingencies. The trust grants broad discretionary powers to the trustee. These complicated forms of trust require extensive professional effort to complete. It is an investment in a professional relationship, one that can improve the overall estate plan.
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