By Linda Toga

THE FACTS: I had my will prepared years ago. The estate tax exclusion amount at the time was considerably less than it is now, so my will contains a provision that directs my executor to create a credit shelter trust to avoid estate taxes. The trust provision mandates that the credit shelter trust be funded with assets equal in value to the estate tax exemption amount in effect at the time of my death.

THE QUESTION: A friend told me the credit shelter trust language that is currently included in my will could result in only a small part of my estate, if any, passing directly to my wife. Is he correct?

THE ANSWER: Without knowing the size of your estate, it is impossible to say how much of your estate might pass directly to your spouse upon your death. That being said, your friend is correct.

Credit shelter trusts are designed to avoid estate tax, but tax avoidance is generally not an issue when the first spouse dies because the surviving spouse is most often the beneficiary of the deceased spouse’s estate.

Regardless of the value of the assets that pass to a surviving spouse as sole beneficiary, there will be no estate tax liability on the first death because both the federal and New York State tax codes include an unlimited marital deduction. That means the assets passing to the surviving spouse pass estate tax free.

In contrast, the value of assets passing to a nonspouse may trigger estate tax. That is why estate tax can become a problem when the surviving spouse dies. If the value of the surviving spouse’s estate exceeds the applicable estate tax exemption amount then in effect, estate tax will be due. This year the federal estate tax exemption is currently at $5.49 million and the New York State exclusion amount is currently at $5.25 million.

If your will directs that assets equal in value to the current estate tax exemption amount go into the credit shelter trust, over $5.2 million of your probate estate must be used to fund the trust. The actual dollar amount will depend on whether your will references the federal or the New York State exemption/exclusion amount. If the value of your assets does not exceed the exemption amount, the only assets passing directly to your spouse will be jointly held assets and assets on which she is a named beneficiary. Assets that are used to fund the trust will be available to your spouse under certain conditions. She will not have unfettered access to those funds.

Credit shelter trusts were very popular with my clients when the estate tax exclusion amounts were significantly smaller. In 2008, for example, when the federal estate tax exemption was $2 million, clients with estates valued at $3 to $4 million felt comfortable funding a credit shelter trust since the surviving spouse would still receive $1 to $2 million outright. However, since the exclusion amount has increased at a much faster rate than the value of most people’s estates, the language in many credit shelter trusts has become a problem.

One way to address the problem is to have a new will prepared that does not direct your executor to create a credit shelter trust. However, if you are concerned about estate tax liability, another option is to have a new will prepared that includes language limiting the value of the assets that must be used to fund a credit shelter trust. That way you can be sure that there are sufficient assets passing to your spouse outright.

A third option is to include a discretionary marital trust in your will, rather than a credit shelter trust. A disclaimer trust, for example, can be used by married couples to avoid estate taxes and has the advantage of allowing the surviving spouse to decide how much money will go into the trust. If the surviving spouse feels comfortable doing so, she can have the trust funded with assets equal in value to the applicable exclusion amount. However, she can also decide to fund the trust with a lesser amount or to not to fund the trust at all.

The surviving spouse has nine months to decide whether it makes sense taxwise to fund the trust. Because of the flexibility offered by disclaimer trusts, and the ability to essentially do post-mortem planning, many people whose estates are valued at over the exclusion amount find disclaimer trusts a good option. To figure out what would be best for you, you should discuss your situation with an experienced estate planning attorney.

Linda M. Toga, Esq. provides legal services in the areas of estate planning, probate, estate administration, litigation, wills, trusts, small business services and real estate from her East Setauket office.