A General Strategy for Reducing Estate Tax

Credit Shelter TrustEstate tax planning is a vital part of your end-of-life plan, especially if you want more money to go to your family than to the government. Not all estate planning attorneys make decisions on the basis of taxes, so it is important to find an attorney with tax experience or hire an accountant to review your estate plan.

Each year, Congress defines an amount of money that will be exempt from estate tax. The 2011 and 2012 rates exempt the first $5,000,000 ($5 million) of an individual’s estate from federal taxes. This amount may seem high, but remember that the total value of your estate includes not just the money you have in the bank, but also the value of your home, car, jewelry, electronics, and all other property. The worth of your estate can grow quickly, and it is important to have a plan to reduce the amount in taxes you must owe.

Clever estate planners make use of two tools: the credit shelter trust and the marital deduction.

Credit Shelter Trust (A-B Trust or Bypass Trust)
Whatever amount is exempted from estate tax — $5 million in 2011 and 2012 — goes into the credit shelter trust. Your children are named as the beneficiaries of the trust, and your surviving spouse may collect any income from the money or assets in the trust. For instance, the credit shelter trust might include a $650,000 house from which the surviving spouse continues to collect monthly rental income before the house transfers to the children when both parents die.

This setup allows the first spouse to use the entirety of the yearly exemption to transfer assets to his or her children, but allows the spouse to continue to use and enjoy the assets during their lifetime.

Marital Deduction
Transfers to spouses are exempt from estate tax with no limit. Whatever funds are remaining after the annual exemption amount is put into the credit shelter trust may be freely transferred to the surviving spouse with no tax implications.

This may make the credit shelter trust seem unnecessary. While it is true that you can transfer all of your assets to your spouse without paying estate tax, consider what happens when your spouse dies. For instance, assume that you have $4 million in assets and your spouse has $3 million. When you die, you transfer $4 million to your spouse and pay no estate taxes. When your spouse dies, $7 million is transferred to your children and estate taxes are due on $2 million (the remaining amount above the $5 million exemption).

With a credit shelter trust, your $4 million would instead go into that trust. Your spouse would still be able to use and benefit from the assets. Then when your spouse dies, your children inherit the $4 million trust (tax-free, as it used your exemption when you died) and $3 million from your spouse (also tax-free, as it uses your spouse’s exemption). In essence, a credit shelter trust allows you to double your estate tax exemption.

Of course, only you and your attorney can determine if this plan is right for your situation. Estates are very variable, and a plan that works well for one person may not work for another.