Clients may be considering (or reconsidering) their estate plans given the changes in the estate tax exemption over the years. For example, is a trust for the surviving spouse necessary and, if so, what type of trust? This article outlines the factors that must be contemplated along with the key differences between disclaimer trusts and credit shelter trusts.
If assets are left outright to a spouse, there is no estate tax when the first spouse dies due to the “marital deduction.” The first deceased spouse’s assets are included in the surviving spouse’s estate. Due to “portability” under federal law, a deceased spouse’s unused federal estate tax exemption passes to the surviving spouse (with certain caveats) and the surviving spouse will get the benefit of both spouses’ federal estate tax exemptions.
However, because there is no portability for the state estate tax exemption or for the federal generation-skipping tax exemption, those exemptions would be wasted if the assets passed outright to the surviving spouse. Instead, the first deceased spouse creates a trust (known as a credit shelter trust) for the surviving spouse (by Will or revocable trust) which holds the amount that can pass free of federal and state estate tax. Those trust assets (no matter how large they grow) will not be included in the surviving spouse’s estate. After the surviving spouse’s death, those trust assets can continue to be held in generation-skipping lifetime trusts for the children and not be included in the children’s estates.
The surviving spouse can have many powers over the trust. The surviving spouse can be the sole trustee and distribute income and principal as long as there are certain restrictions (e.g., can distribute for health, education, maintenance and support; can also distribute up to 5% principal each year without any reason needed). The surviving spouse also can have the power to appoint an independent co-trustee (basically anyone who is not a beneficiary of the trust) who may distribute for “best interests” or even terminate the trust in the future and distribute the assets to the surviving spouse (e.g., if the estate tax were eliminated). In addition, the surviving spouse can be given a “power of appointment” which allows them to change how the trust will pass when the surviving spouse dies, usually limited by the trust terms to their descendants or charities (e.g., if a child has creditor problems in the future, a trust can be created for the child instead of leaving assets outright).
An alternative to the credit shelter trust is a disclaimer trust. The first deceased spouse leaves all assets to the surviving spouse who then has until nine months after the first spouse dies to choose not to accept all of the assets. The disclaimed assets would be held in trust. While the disclaimer trust provides flexibility as to what assets, if any, will be held in trust, this type of trust has some drawbacks. The surviving spouse cannot be given a power of appointment. Another potential problem is that, if the surviving spouse inadvertently exercises any control over an asset after the first spouse dies (e.g., by selling assets or withdrawing money from an account), they cannot later decide to disclaim that asset. For these reasons, the disclaimer trust option may be recommended when there is no expectation that the surviving spouse will disclaim (e.g., because the couple’s combined assets are likely to be under one exemption amount), allowing for flexibility in case it is needed. A credit shelter trust is a better option when it is more likely that the trust will be needed in order to use the first spouse’s exemption and avoid any estate tax on the surviving spouse’s death.
For clients who might move to a state that does not impose an estate tax (such as Florida), the question is whether this should affect whether to include a disclaimer trust or a credit shelter trust. Since it is not uncommon for couples who relocate to Florida (or another tax-friendly state) to later return to Connecticut because their children and grandchildren reside here (or the surviving spouse moves back to Connecticut after the first spouse dies), the possibility of moving out of state, in most cases, should not be a strong factor in this analysis. For more information, please contact Lisa F. Metz (lmetz@brodywilk.com) or another BW attorney.
