August 27, 2018
In years past, many Wisconsin couples set up credit shelter trusts as part of their estate planning, to avoid or reduce Wisconsin and Federal estate taxes upon death. Due to changes in Wisconsin and Federal estate tax laws, many credit shelter trusts are no longer necessary. They should be revised to save time and expense.
What is a Wisconsin Credit Shelter Trust?
Credit shelter trusts have many names in Wisconsin. Common names for a joint revocable trust that splits into two trusts at the death of the first spouse are known as an A and B Trust, Marital Trust, Survivor’s Trust, and Family Trust. When the first spouse passes, the original trust splits the assets into two separate trusts, to shelter a portion of the assets from future estate taxes.
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Why Use Credit Shelter Trusts?
The primary reason for setting up credit shelter trust in Wisconsin was to avoid the Wisconsin estate tax and to avoid or limit the federal estate tax. This was accomplished by allowing the original revocable trust to split into two separate trusts upon the first spouse’s death. This split allowed the surviving spouse to double the amount that would escape Wisconsin and Federal estate taxes.
(For simplicity when we refer to “family trust”, we will refer to the irrevocable credit shelter trust created upon the death of the first spouse.)
When to Revise a Wisconsin Credit Shelter Trust?
Due to changes in the Federal Estate tax laws and the elimination of the Wisconsin estate tax, many couples with Wisconsin credit shelter trusts will no longer benefit from having a such a trust. In fact, many Wisconsin couples will be hurt by having a credit shelter trust due to increased trust administration expenses and increased complexity upon the death of the first spouse.
Splitting the original revocable trust into two separate trusts upon the death of the first spouse requires the filing of a complex 706 estate tax return, obtaining an EIN for the family trust and additional ongoing 1041 income tax returns and asset retitling. In short, there is significant cost and work to splitting a trust into the required two trusts upon the death of the first spouse.
With today’s tax laws, this extra work and cost is only worth it when there will be significant estate tax savings. While there are some other potential benefits to a credit shelter trust arrangement, the primary benefit was avoiding estate tax.
No Estate Tax Issue: Is a Credit Shelter Trust Worth It?
If there are not estate tax issues, the extra cost time, and hassle may not be worth the limited value of having the original trust split into two separate trusts. Therefore, it may be best to amend the original revocable trust to no longer provide for the division into two trusts upon the first spouse to pass. This amendment can be a relatively simple and inexpensive process if both spouses are still living and able to sign.
The Funded Credit Shelter Trust: Revising Credit Shelter Trusts If a Spouse Has Already Passed
With credit shelter trusts, once the first spouse passes, the family trust is an irrevocable trust in order to comply with IRS estate tax regulations. So, the surviving spouse cannot simply amend the credit shelter trust to eliminate the division into two trusts. However, all is not lost.
Through a Non-Judicial Settlement Agreement, it is possible to revise an irrevocable trust even after the first spouse has passed away. Doing so requires cooperation from the surviving spouse and all of the “qualified” beneficiaries of the trust along with the trustee.
(Although beyond the scope of this article, we will discuss the use of Non-Judicial Settlement Agreements in Wisconsin in a future article. We will cover how these can be used to revise and amend irrevocable trusts.)
Estate Tax Changes – Focus on Eliminating Capital Gain Taxes
In the past, when estate taxes were higher than capital gains tax, it made sense to divide trusts to avoid paying estate taxes. However, the tradeoff was that the credit shelter trust assets would likely end up paying capital gains tax upon the death of the surviving spouse.
Now, when estate taxes are no longer an issue, revising an existing funded credit shelter trust is still possible. Doing so may be the best course of action to eliminate or reduce capital gains taxes.
Simply put, certain tax provisions can be added to the irrevocable trust to trigger estate tax inclusion in the taxable estate of the surviving spouse upon the surviving spouse’s death.
(Although beyond this article’s scope, we may include a “power of appointment” in favor of the surviving spouse in the family trust. We might also include a right of the surviving spouse to amend, alter, revoke or terminate the beneficial enjoyment of said trust. As this is cutting edge estate planning, many of these revisions have not fully made it through the court system.)
Revising Existing Funded Credit Shelter Trusts is Complicated
In an existing funded credit shelter trust, the best way to eliminate capital gains tax is very complicated. By including the family trust assets in the estate of the surviving spouse (where this will not create an estate tax), we can obtain a step-up in basis upon the death of the surviving spouse thereby reducing or eliminating capital gains tax.
Do You Have a Wisconsin Credit Shelter Trust?
Our estate planning attorneys have created and reviewed thousands of joint revocable trusts and credit shelter trusts for our Wisconsin clients. We can review older Wisconsin trusts and determine, based upon the trust, family situation, assets, and more, the best course of action to take with Wisconsin credit shelter trusts. We invite you to contact us today to discover how we can help you.