Credit Shelter Trust
A bypass trust, which is also called a credit shelter trust, is a method used to minimize estate taxes payable by a married couple. While many tax-minimizing strategies are available, the bypass trust is uniquely designed to allow both spouses to utilize their federal estate tax exemptions under current tax law. Here is how it works. When the first spouse dies, the estate is divided into two parts: - One part, an amount up to the estate tax exemption allowed by law, is placed in the bypass trust. In 2003, this amount is $1,000,000; it gradually increases over the years, reaching $3,500,000 in 2009, the year before the estate tax is scheduled for a one-year repeal. The amount placed in the bypass trust avoids estate tax up to the exemption amount in the year of death.
- The other portion of the estate may be passed directly to the surviving spouse or placed in a marital trust and held for the benefit of the spouse. In either case, because of the unlimited marital deduction, this portion also escapes estate taxation, regardless of its value.
The surviving spouse may receive income for life from the bypass trust. The trust is usually established so that the principal that was deposited in the trust at the first death is retained for later passage to heirs when the second spouse dies. However, in addition to receiving income, the surviving spouse has liberal rights in the trust that allow her or him to: - Withdraw principal for purposes of health, education, support and maintenance.
- Exercise a limited power of appointment over the trust principal, i.e., spouses may be able to appoint the principal to anyone except themselves, their estates, their creditors, or the creditors of their estates.
- Withdraw annually the greater of $5,000 or 5% of the principal.
Despite these generous rights to income and principal, the bypass trust is not included in the surviving spouse's gross estate at death. When the second spouse dies, the bypass trust may terminate or continue. All assets remaining in the trust at the second death are either distributed outright to the heirs, or held in trust for the benefit of the heirs if the trust agreement so specifies. This latter arrangement is especially beneficial when the heirs are minor children or persons who have not demonstrated financial responsibility. Any assets owned by the surviving spouse outside the bypass trust will be included in the spouse's estate for taxation. Strategies are available to the surviving spouse to reduce the amount that is subject to estate taxation. Although bypass trusts are typically used by married couples to benefit the surviving spouse, these trusts can be set up to provide income for someone other than the spouse. A trust might be payable to the couple's children or grandchildren, but anyone could be named: an aged dependent parent or other relative, for example. Although the trust beneficiary is frequently a relative, he or she need not be. Regardless of who is the beneficiary of the bypass trust, the same rules apply. That is, remaining trust assets at this person's death will not be included in his or her gross estate and may, instead, benefit heirs without estate tax depletion. Bypass trust agreements may be set up with a number of variations suited to a particular person's needs. For example, the trustee or the surviving spouse may have discretion to provide income for several beneficiaries-the spouse plus the children or others designated in the agreement. Another variation might allow the survivor to borrow on arm's length terms from the principal in the trust, but not to make withdrawals of principal. It is always vital to consider the tax consequences of any customization of the trust to be certain both spouse's estate tax exemptions are used effectively and no tax benefits are lost. |
