Rethink the Credit Shelter Trust

For many years, New Jersey resident married couples with estates that exceeded the estate tax exclusion amount routinely implemented Wills that contained a two part trust scheme – a credit shelter trust funded in the amount of the available estate tax exclusion and a marital trust. The merits of continuing to use a credit shelter trust to avoid the New Jersey Estate Tax must be revisited. The reasons for the shift in planning – (i) a trust’s income taxation is similar to individuals, but the tax brackets are very compressed; (ii) assets which fund a credit shelter trust do not receive a basis adjustment at the death of the surviving spouse; and (iii) post-mortem domicile planning or gifting strategies can be implemented to avoid the New Jersey Estate Tax.

To illustrate, assume that a New Jersey resident couple, both aged 70, have a $2,000,000 estate and they signed Wills using the conventional two-trust plan. If one spouse dies in 2014, a credit shelter trust will be funded with assets valued at $675,000. The actuarial life expectancy of the survivor is approximately 15 years. At an annual rate of return of 5%, the credit shelter trust will appreciate $751,750 in value during the life of the survivor. If the remainder beneficiaries of the trust sell the appreciated trust assets upon the death of the survivor, there is no step-up in basis and the capital gains tax on the sale will be $112,762 at the current capital gains tax rate of 15%.

The merits of the two-part trust scheme should be re-evaluated because the evolution of the tax laws has given estate planners an array of planning options less likely to result in the payment of a significant capital gains tax. If a surviving spouse inherits assets outside a trust and changes domicile to a state that does not impose a state estate tax or engages in a gifting program, the state estate tax can be significantly reduced or avoided entirely. In addition, the assets owned by the survivor will receive a step-up in basis and the capital gains tax can be avoided.

In any instance where limited or no New Jersey Estate Tax is anticipated, or when the anticipated capital gains tax exceeds the expected state estate tax, there is no longer a tax justification to automatically establish a credit shelter trust. Instead, an experienced estate planning attorney can assist with the preparation of a Will utilizing a “disclaimer trust” or a “Clayton QTIP” trust. In each technique, the decision as to whether a state estate tax planning strategy will be implemented is deferred until the death of the first spouse. At such time, the surviving spouse or the Executor named in the Will can undertake the appropriate analysis and make the correct tax election based on the then current laws and the intentions of the surviving spouse.