Increasing your estate planning power: How you can ?°supercharge?± a credit shelter trust

For a long time, the loan shelter trust is a standard weapon in married couples’ estate planning arsenals. Today, however, a $5.34 million estate tax exemption amount coupled with portability of exemptions between partners implies that traditional estate planning automobiles are less critical compared to what they were in the past. Nonetheless, credit shelter trusts still offer significant benefits, designed for high-internet-worth taxpayers.

Affluent families searching for methods to lower their gift and estate tax bills should think about a Supercharged Credit Shelter TrustSM (SCST)*. An SCST enhances the advantages of a standard credit shelter trust.

Making the most of the exemption

To know how an SCST works, some background around the credit shelter trust is essential. A credit shelter trust was created to benefit from each spouse’s exemption and be sure that neither is wasted. Suppose, for instance, that Jane’s estate may be worth $15 million. If she leaves all her wealth outright to her husband, Allan, the limitless marital deduction will shield it from estate taxes. Before portability, if Allan would die and then leave $15 million towards the couple’s children, his estate would owe $3,864,000 in estate taxes (presuming a $5.34 million exemption along with a 40% tax rate).

Had Jane generate a testamentary credit shelter trust, the goverment tax bill could have been substantially smaller sized. The trust, funded by having an amount comparable to Jane’s estate tax exemption ($5.34 million) provides Allan by having an earnings interest for existence, then the funds would then visit the couple’s children. The trust would make the most of Jane’s exemption and, by restricting Allan’s legal rights towards the trust principal, the funds would bypass his estate. The rest of the $9,660,000 in Jane’s estate would pass to Allan either outright or perhaps in a marital trust. When Allan dies, presuming his estate may be worth $9,660,000 (and also the exemption amounts and tax rates haven’t altered), the estate tax could be $1,728,000, for any $2,136,000 savings.

Portability enables a few to benefit from both spouses’ exemptions without resorting to a credit shelter trust or any other sophisticated estate planning tools. Provided certain needs are met, portability enables a making it through spouse to include a deceased spouse’s unused exemption add up to his very own. So, in the last example, Jane might have left $15 million to Allan outright, and Allan might have added Jane’s exemption to their own, shielding $10.68 million from taxes in the estate. Presuming Allan’s estate continues to be worth $15 million as he dies, the estate tax liability could be $1,728,000 ($15 million – $10.68 million × 40%), exactly the same tax outcome like a credit shelter trust.

There are many disadvantages to depending on portability, though. First, unlike a credit shelter trust, portability doesn’t shield future earnings and appreciation from estate taxes. Suppose, for instance, that Jane’s estate plan establishes a credit shelter trust funded with $5.34 million in assets. If, when Allan dies, the trust’s value is continuing to grow to $8.34 million, the $3 million in appreciation will bypass Allan’s estate and escape estate taxes. Had Jane depended on portability, that $3 million in growth would finish in Allan’s estate, potentially triggering yet another $1.two million in estate taxes.

Second, portability doesn’t affect the generation-skipping transfer (GST) tax exemption. So, for couples who would like to preserve both spouses’ GST tax exemptions to lessen taxes on gifts for their grandchildren, a credit shelter trust is the greatest option.

Finally, credit shelter trusts offer some defense against creditors’ claims from the trust assets. Outright gifts offer no such protection.

Enhancing the benefits

One disadvantage to a standard credit shelter trust is the fact that taxes around the trust’s earnings hamper being able to grow and compound for the advantage of the trust beneficiaries. Underneath the complex distributable net gain rules, trust earnings is taxed towards the trust in order to the beneficiaries (or both), with respect to the quantity of distributions the trust makes every year. In either case, these taxes erode the trust assets, departing less for that beneficiaries.

An SCST “supercharges” the loan shelter trust by making certain that it is treated like a grantor trust with regards to the making it through spouse. As grantor, the making it through spouse pays the required taxes around the trust’s earnings, permitting the trust assets to develop tax-free for that beneficiaries.

Underneath the grantor trust rules, the grantor’s tax repayments don’t constitute taxed gifts towards the beneficiaries. Basically, by having to pay taxes that will otherwise emerge from the trust’s earnings, the grantor bakes an additional, tax-free offer towards the beneficiaries.

How can you ensure grantor trust treatment? In the end, credit shelter trusts ordinarily are in place by bequest based on the deceased spouse’s will or revocable trust, therefore the deceased spouse may be the grantor.

One of the ways is to own making it through spouse the authority to withdraw trust principal, however this would make the trust assets to become incorporated in their estate. The important thing for an SCST is perfect for the spouse who ultimately would be the making it through spouse to setup an eternity qualified terminable interest property (QTIP) trust to finance a credit shelter trust from the first spouse to die. The QTIP trust assets is going to be incorporated within the deceased spouse’s estate, and also the making it through spouse is going to be treated because the grantor (for tax reasons) from the credit shelter trust produced in the QTIP trust. (Remember that, with this technique to work, the beneficiary spouse should be a U.S. citizen. Otherwise, the QTIP trust won’t entitled to the marital deduction, exposing the trust to gift tax.)

Careful drafting required

To create an SCST work, you have to consider numerous complex gift and estate tax rules, such as the reciprocal trust doctrine. (Begin to see the sidebar “Watch out for reciprocal trusts.”) Careful drafting is needed to prevent triggering unnecessary gift, estate or earnings taxes.

* “Supercharged Credit Shelter TrustSM” is really a service mark of Mitchell M. Gans, Jonathan G. Blattmachr, and Diana S. C. Zeydel, whose article about this subject seems within the This summer/August 2007 issue of Probate & Property magazine.

Sidebar: Watch out for reciprocal trusts

Typically, a few wishing to benefit from a Supercharged Credit Shelter TrustSM (SCST) each establishes an eternity qualified terminable interest property (QTIP) trust for the advantage of another, made to fund a credit shelter trust for the advantage of the making it through spouse. A few who create identical trusts simultaneously risk running afoul from the reciprocal trust doctrine, which could solve an SCST’s tax benefits. The doctrine prohibits a few from staying away from taxes by utilizing trusts that 1) are related, and a pair of) place each grantor within the same economic position as though they’d each produced trusts naming themselves as beneficiaries.

For SCSTs, the greatest risk would be that the IRS will invalidate the QTIP trusts, resulting in the entire amount led towards the trusts to become taxed gifts. There are many methods to steer clear of the reciprocal trust doctrine, including giving each QTIP trust beneficiary a unique power appointment, different the the trusts so they’re not identical or creating the trusts at different occasions.