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Don’t ditch your credit shelter trust: Estate taxes still loom

by on
in Small Business Tax Deduction Strategies

Are you thinking about dismantling the credit shelter trust you set up years ago? Not so fast.

Strategy: Don’t discard an existing trust just yet. There are still plenty of reasons for keeping the trust.

The new estate tax rules in the 2010 Tax Relief Act that seemingly discourage the use of credit shelter trusts are scheduled to “sunset” after 2012.

Here’s the whole story: Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the federal estate tax exemption crested in 2009 at $3.5 million, with a top estate tax rate reduced to 45%. Then the estate tax was completely repealed, but only for decedents dying in 2010.

EGTRRA provided comparable changes for the generation-skipping tax (GST). Also, the rules allowing a step-up in basis on inherited assets were replaced by modified “carryover basis” rules for estates of individuals who died in 2010.

For 2011 and 2012, the 2010 Tax Relief Act increases the estate tax exemption to $5 million, with a top estate tax rate of 35%. The new law also replaces the modified carryover basis rules with the “step-up in basis” rules that existed prior to 2010. It also allows for “portability” of any estate tax exemption for married couples. If a deceased spouse’s estate doesn’t use up the entire exemption, the remainder is available to the estate of the surviving spouse.

Previously, upon the death of the first spouse, an amount equal to the maximum exemption could be transferred to a trust for the children. When the second spouse died, that person’s estate (which would also usually go to the children) would be sheltered by his or her separate exemption.

The new rules seem to eliminate the need for a credit shelter trust. But be aware:

  • The estate tax provisions in the new law expire after 2012. If Congress doesn’t act again, it reverts to $1 million in 2013, with a top 55% tax rate and no portability for exemptions.
  • Twenty-two states and the District of Columbia have their own estate taxes or inheritance taxes. The exemptions for most of those taxes are much less than $5 million. So families are still potentially at risk for state estate taxes.
  • Portability does not apply to the GST exemption. The GST exemption is $5 million, so a grandparent may want to take advantage of this.

The maximum that can be sheltered under the portability provision is $10 million. Other estate planning techniques can help protect assets that will appreciate above the $10 million mark.

Based on the new estate tax rules, a credit shelter trust may be amended, but it should generally be preserved for the future. For instance, a trust may be made compatible with the current $5 million exemption amount to avoid leaving too much or too little to a surviving spouse.

Tip: A trust can provide other benefits such as protection from creditors and restraints on spending.

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