Credit Shelter Trust

Cornelius and Beatrix Wenlock hold a combined estate of about $9,000,000, mostly in jointly titled accounts. Their attorney proposes retitling so that on the first death an amount equal to the deceased spouse remaining federal estate tax exclusion funds a CREDIT SHELTER (bypass) trust paying income to the survivor for life, with the remainder to their children. Compared with leaving everything outright to the survivor and relying on portability, the bypass trust:

1. A.Produces a second basis step-up at the survivor death that portability does not provideExactly backwards. Bypass trust assets are not in the survivor estate, so they receive no second step-up.
2. B.Keeps the sheltered assets and their future appreciation out of the survivor estate and locks in who ultimately receives them, at the cost of forgoing a second basis step-up and adding trust administrationCorrect. Growth is sheltered and the remainder is protected; the price is basis and complexity.
3. C.Eliminates income tax on the trust investment income, because a credit shelter trust is a tax-exempt entityThe trust is a taxable entity. Undistributed income is taxed to the trust, and trust brackets compress very quickly.
4. D.Is unnecessary in every case, because portability preserves the deceased spouse unused exclusion automatically with no filing requiredPortability must be elected on a timely filed estate tax return, and it does not shelter post-death appreciation or control the remainder beneficiaries.

Why: A funded bypass trust removes the sheltered assets AND all their subsequent appreciation from the surviving spouse taxable estate, and it fixes the ultimate remainder beneficiaries so that a remarriage or a later will cannot redirect them. Those are its two real advantages over portability. The costs are that the trust assets receive no second basis step-up at the survivor death, that the trust must be administered and file its own returns, and that trust income retained inside the trust reaches the top bracket at a very low income level.

Bartholomew Fenn is in his second marriage. He wants his wife Ilse to receive all the income from a $5,000,000 trust for her lifetime, wants the remainder to pass to the children of his first marriage, and wants the trust to qualify for the federal estate tax marital deduction at his death. His attorney recommends a QTIP trust with the proper election. Which statement is correct?

1. A.For the trust to qualify, Ilse must hold a general power of appointment over the trust corpus.Incorrect. That describes a general power of appointment marital trust, which necessarily lets the surviving spouse redirect the remainder. The QTIP election exists specifically so that is not required.
2. B.The trust qualifies for the marital deduction at Bartholomew's death and its value escapes estate tax in Ilse's estate as well.Incorrect. The marital deduction defers rather than eliminates the tax. Electing QTIP property is included in the surviving spouse's gross estate at her death.
3. C.Ilse must receive all trust income at least annually and no one may appoint any part of the trust to anyone other than her during her life; the executor's election secures the marital deduction, and the consequence is inclusion of the remaining value in Ilse's gross estate while Bartholomew controls the remainder.Correct. This states the qualifying conditions, the elective nature of the treatment, and the trade-off - deduction now in exchange for inclusion in the survivor's estate later.
4. D.Because Ilse cannot control the disposition of the remainder, the trust cannot qualify for any marital deduction.Incorrect. That would be true of an ordinary terminable interest, but the QTIP election is the statutory exception permitting a marital deduction without giving the survivor control of the remainder.

Why: A qualified terminable interest property trust solves exactly this problem. Ilse must be entitled to all the trust income, payable at least annually, for life, and no person - including Ilse - may hold a power to appoint any part of the trust property to anyone other than Ilse during her lifetime. If the executor makes the QTIP election on the estate tax return, the trust qualifies for the marital deduction even though Ilse has no control over the remainder, so no estate tax is due at Bartholomew's death. The price of that deduction is that the trust's remaining value is included in Ilse's gross estate when she dies. Bartholomew, meanwhile, keeps the remainder locked for his first-marriage children.