What is a credit shelter trust?

A credit shelter trust, also known as a bypass trust, is a type of irrevocable trust that is designed to take advantage of the estate tax exemption. The estate tax exemption is the amount of an estate that is exempt from federal or state estate tax, which can be a significant portion of an individual's estate.

With a credit shelter trust, upon the death of the first spouse, the decedent's assets are transferred to the trust, up to the amount of the estate tax exemption, rather than passing directly to the surviving spouse. This means that the assets held in the trust are not included in the surviving spouse's estate for estate tax purposes, and can be passed on to the couple's heirs tax-free when the surviving spouse eventually passes away.

For example, suppose an individual has an estate worth $10 million and the estate tax exemption is $5 million. If the individual passes away, $5 million of their assets can be transferred to a credit shelter trust, with the remaining $5 million passing to the surviving spouse. Since the assets in the credit shelter trust are not included in the surviving spouse's estate, they can be passed on to the couple's heirs without being subject to estate tax.

Credit shelter trusts can also provide other benefits, such as asset protection, as the assets held in the trust are generally protected from creditors and lawsuits.

It's important to note that the use of credit shelter trusts is subject to federal and state tax laws, which can be complex and can change over time. It's recommended that individuals consult with a qualified estate planning attorney or tax professional to determine whether a credit shelter trust is appropriate for their specific situation.