What is a “Credit Shelter Trust (a “CST”)”:
A: The Credit Shelter Trust (the “CST”) is a mechanism to allow a spouse to use (not waste) the full estate tax exemption. The beneficiaries of the trust are usually the children. The spouse receives a life estate and has full use of the income and can even use the principal in limited circumstances for his or health and maintenance.
A “QTIP” is a “CST.” If the present state of the federal law does not change, in 2011 everyone will have a $1M amount exempt from estate taxation. When a spouse dies, he can leave his assets to his surviving spouse using what is called the “Marital Deduction” which is UNLIMITED in amount and under which no taxes are ever owed. That all sounds great but there is a downside. The downside is that if the Marital Deduction is used the ESTATE TAX EXEMPTION is wasted, in other words the spouse does not get to use use it!!!
Look at this example:
H and W both have $1M EACH in assets.
Under Scenario 1, H dies and leaves everything to W, which means that she now has $2M. If she dies with the $2M, only $1M will be exempt from estate taxation and the remaining $1M will be taxed. Why? Because the husband’s exemption doesn’t carry over to her (they WASTED IT). Result, up to $550k in taxes.
In Scenario 2, a valid CST is used as described above with a life estate to the W and the beneficiaries being the children. Under this result, the husband’s ESTATE TAX EXEMPTION is preserved while at the same time the wife is provided with the income generated by the trust assets. When the W dies, the assets pass to the children TAX FREE through the H’s TAX EXEMPTION preserved through the Credit Shelter Trust.
