Many married couples have estate plans which take advantage of the federal and state estate tax exemption of the first spouse to die by holding that exemption amount in what is commonly known as a “credit shelter trust” (also sometimes referred to as a bypass trust).  When the surviving spouse dies, the assets in the credit shelter trust are not included in the surviving spouse’s estate.  If all assets were simply left outright to the surviving spouse, then the first spouse to die’s state estate tax exemption would be wasted since those assets would be included in the surviving spouse’s estate.  (The federal estate tax exemption of the first spouse to die would not be wasted since the tax code now allows for the “portability” of a deceased spouse’s unused federal estate tax exemption to the surviving spouse with certain caveats.)

A credit shelter trust is no longer needed by some clients due to the great increases in the federal and state estate tax exemptions over the years.  The Connecticut exemption matches the federal starting in 2023.  The exemption is $12,920,000 with inflation adjustments each year (scheduled to go back down to around $7,000,000 starting in 2026 unless legislation passes changing the exemption).  Thus, if the couple’s combined assets are under $7,000,000, then a credit shelter trust is not needed when the first spouse dies.  In fact, many clients might be better off without a credit shelter trust since assets that pass outright to the surviving spouse will receive a step-up in income tax basis based on the date of death value of the assets if the assets have appreciated.  Assets held in the credit shelter trust do not get the step-up in basis when the surviving spouse dies.  (Of course, there are reasons that couples may wish to have a trust for the surviving spouse unrelated to tax savings such as second marriage, need for asset protection, or need for protection from those who would take advantage.)

Where both spouses are alive and competent, we can make changes to both of the estate plans to build in flexibility (such as including a disclaimer trust instead of a built-in credit shelter trust).  However, where one spouse has already died, what can the surviving spouse do if the credit shelter trust is already in place and no longer needed?

If the trust provides an independent trustee (i.e., not a beneficiary) with broad discretion to distribute the trust assets to the beneficiaries, then the trustee might be able to distribute the trust assets to the surviving spouse and terminate the trust.  It is also possible to distribute some but not all assets to the surviving spouse, namely those assets which have a low basis and would get a step-up if owned by the surviving spouse at death.  (It is better to keep in the trust those assets with a fair market value less than the tax basis so that there is no basis adjustment of those assets.)  If the trust is set up under a revocable trust agreement, then this may be accomplished without the need for court filings.  However, the trustee may wish to have a release agreement signed by the remainder beneficiaries who would have inherited if the trust had ended on the surviving spouse’s death (usually, the children).  They would not be consenting but rather recognizing that the trustee is exercising its discretion in a proper fashion.  If the trust is set up under a Will, then the termination of the trust can be included as part of a final accounting to be submitted to the probate court for approval.

If the trust instead allows for distributions to a beneficiary for health, education, maintenance and support (known as a “HEMS standard”), then distributions may be made in accordance with that standard.  Usually, the surviving spouse is the sole trustee of this type of trust since those powers will not cause the trust to be included in the surviving spouse’s estate under the tax code.  Since the HEMS standard terms do not have specifications for what meets the standard, they may be broadly interpreted by the trustee (e.g., distributing assets so that the surviving spouse can pay off a mortgage).  The surviving spouse as trustee may wish to have a release agreement in this case as well.

Alternatively, a trustee or beneficiary may petition the court to modify the terms of a trust.  A petition may be brought under Connecticut law if, because of circumstances not anticipated by the settlor, modification or termination will further the purposes of the trust.  To the extent practicable, the modification is to be made in accordance with the settlor’s probable intention.  In this scenario, the petitioner could make the case that the credit shelter trust was only established to save potential estate tax on the surviving spouse’s death; is no longer needed due to the increased exemptions; and should be distributed to the surviving spouse.  Consent of the remainder beneficiaries is not needed with this type of petition (which avoids the issue of whether the beneficiaries are making a gift to the surviving spouse).  For more information, please contact Lisa F. Metz or another BW attorney.