Credit shelter trust

A credit shelter trust is a tax planning trust which assures that your federal estate tax exemption is “sheltered” rather than wasted by your death. It can be established during your lifetime or upon death depending on whether you want to avoid probate or not. Currently, it allows each of you and your spouse to pass on an estate worth up to $2,000,000.00 without incurring any transfer taxes. This is called the "applicable exclusion amount." However, beginning in 2011, that amount drops to $1,000,000.

Here is how it works:

The government currently allows individuals to pass on an estate worth up to $2,000,000.00 without incurring estate taxes. However, spouses are exempt from this rule and have the ability to give an unlimited amount to each other during life or at death. This unique exemption from estate and gift taxes is called the "marital deduction" and much planning is done to avoid its traps.

Lets say that your combined estate is worth $2,000,000 and you have a will leaving everything to your spouse. If you die first in your estate will not incur any transfer taxes since the marital deduction allows you to pass on an unlimited amount to your spouse. However, if your spouse dies in 2011 and you haven't done proper planning, your spouse's estate will pay $345,000 in federal estate tax since your spouse's estate can only give away $1,000,000 (your spouse's applicable exclusion amount), no longer having a marital deduction because of your death. You will have wasted one unified credit.

If instead your will directs that a $1,000,000 be given to a credit shelter trust for the benefit of your spouse, children or other beneficiaries, you will use your applicable exclusion amount (currently $2,000,000) by funding the credit shelter trust. The remainder $1,000,000 of your combined estate can be used by your spouse upon your spouse's death since your spouse also has the ability to give up to $1,000,000 to anyone without incurring estate tax. Now, you have  avoided paying $345,000 of estate taxes upon your your spouse's death sometime after 2011.