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Credit Shelter Trust

Former Supreme Court Justice Learned Hand is known for his famous quote:

"There is nothing sinister in so arranging one's affairs
as to keep taxes as low as possible."

Yes, it is true that a living trust can be used to save estate taxes. This is done through proper use of the estate tax exclusion and the marital deduction.

Living trust saving tax

Normally, this type of living trust is called a credit shelter trust. This means that the trust shelters the estate tax exclusion or credit. Sometimes it's referred to as an A B Trust (or ab trust). Don't worry if you don't understand what I'm talking about. I'll use an example in a moment.

The point I want to make now is simply that either a living or testamentary trust (normally part of a will) could operate as a Credit Shelter Trust. So, there is nothing about a living trust that inherently saves taxes.

O.K. Let's use an example based on the following assumptions:

Husband dies first (actuarially, a good bet)

The estate tax exclusion is $1,000,000 [see Estate Tax to find out why I make this assumption.]

Husband and wife's total estate value is $2,000,000.

The danger with a simple will is that commonly both wills simply leave everything to the other spouse upon death. Due to the unlimited marital deduction, there is no tax upon the first death and transfer of all assets to the surviving spouse.

The problem happens when the second spouse dies. Now that spouse has $2,000,000 in his or her estate and only a $1,000,000 exclusion. The estate is stuck with an estate tax bill of 45% of $1,000,000 or $450,000. This doesn't count any state estate tax that might also apply.

Through basic estate planning, specifically through use of a credit shelter trust, this couple could have saved over half a million dollars in taxes.

credit shelter

How?

Upon the death of the first spouse, $1,000,000 could have been transferred (tax free) to a credit shelter trust (or family trust or AB Trust) and $1,000,000 (tax free) to the surviving spouse.

The credit shelter trust could be accessed for the support of the surviving spouse during his or her life. After the surviving spouses' death, the assets in the credit shelter trust could be transferred to other beneficiaries (i.e. children, etc) with no estate tax. The assets would transfer estate tax free because the first spouse used his or her $1,000,000 estate tax exclusion on the trust.

The other $1,000,000 would have transferred to the spouse, also tax free, due to the unlimited marital deduction. Upon the second spouse's death, the $1,000,000 he or she received would also pass to his or her heirs (i.e. children, etc), free of estate tax, due to use of his or her estate tax exclusion.

So, $2,000,000 in assets transferred free of estate tax. A tax savings to the estate of at least $500,000 (in the typical case).

OK, so what does this have to do with living trusts? Nothing.

The above maneuver is basic estate planning that can be conducted by use of a living trust or a testamentary trust. (See living trust taxes.)

BUT you do have to have some kind of trust to do it. This type of trust is variously referred to as a:

Credit Shelter Trust

A-B Trust

Marital Bypass Trust

Family Trust, or an

Exemption Trust

Each of the above terms normally refers simply to a trust designed to take full advantage of the federal estate tax exclusion of both husband and wife. Again, it could be a living trust or a testamentary trust.

Estate planning attorney's make their bread and butter drafting Credit Shelter Trust documents to implement this simple strategy. You might pay an attorney $1000 (very rough estimate) to draft the documents. Your heirs save over $500,000 in taxes.

And, those savings are just from estate taxes. Undoubtedly, your estate planning attorney will also help you accomplish other objectives as well. Pretty good return on investment (ROI) if you ask me.

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