For a married couple in New York with substantial assets, estate tax planning can preserve hundreds of thousands or even millions of dollars for the next generation. One of the most useful tools under New York and federal law is the credit shelter trust, also called a bypass trust, family trust or B trust. Properly structured, it shields significant assets from estate tax while providing for the surviving spouse and ultimately benefiting the children and grandchildren.
We design, draft and implement credit shelter trusts for married couples throughout New York, and we help surviving spouses and trustees fund and administer them after the first death.
What Is a Credit Shelter Trust?
A credit shelter trust is an irrevocable trust created at the death of the first spouse. It holds assets up to the amount of the deceased spouse’s available estate tax exemption. Because those assets fall within the exemption, they are not taxed in the first spouse’s estate, and because they belong to the trust rather than to the survivor, they are not taxed in the surviving spouse’s estate either.
The surviving spouse usually receives substantial benefits from the trust during his or her lifetime: the income the trust assets generate, principal distributions for health, education, maintenance and support, limited rights to invade principal under specified standards, and in many cases the ability to serve as trustee or co-trustee. When the surviving spouse dies, whatever remains in the trust passes to the named beneficiaries, typically the couple’s children, free of estate tax in the survivor’s estate.
Why Credit Shelter Trusts Matter in New York
New York imposes its own estate tax separate from the federal estate tax, and three features of the New York system make credit shelter planning especially valuable for New York residents.
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The New York estate tax cliff
Unlike the federal system, which applies a unified credit, New York has what practitioners call the “estate tax cliff.” If a New York taxable estate exceeds the basic exclusion amount by more than 5%, the entire estate, not just the excess, becomes subject to New York estate tax. An estate that marginally exceeds the threshold can face a tax bill out of all proportion to the excess. A credit shelter trust helps a couple avoid the cliff by making sure the first spouse’s exclusion is fully used, which keeps the surviving spouse’s estate below the threshold. Our estate tax cliff calculator shows how the cliff works on actual numbers.
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No New York portability
Federal law lets a surviving spouse use the deceased spouse’s unused exemption through “portability.” New York does not recognize portability. If the first spouse to die leaves everything outright to the survivor, relying on the unlimited marital deduction, the deceased spouse’s New York exclusion is permanently lost. The credit shelter trust solves this: by placing assets equal to the New York exclusion in the trust at the first death, the couple captures both spouses’ New York exclusions, potentially shielding several million dollars of additional assets from New York estate tax.
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Different federal and New York exclusion amounts
The federal and New York exclusions are different amounts and both adjust over time. Coordinating them takes careful drafting, sometimes through a multi-trust structure with a state-level credit shelter trust, a federal credit shelter trust and a marital trust, so that both the state and federal results come out right.
How a Credit Shelter Trust Works in Practice
Consider a married couple living in New York whose combined assets significantly exceed the New York exclusion amount. The plan unfolds in four stages.
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Drafting the estate plan
While both spouses are living, we draft revocable living trusts or wills containing credit shelter trust provisions. The plan typically directs that, at the first death, an amount equal to the deceased spouse’s available exemption is funded into the credit shelter trust, with the remainder passing outright to the surviving spouse or into a marital trust.
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Funding the trust at the first death
When the first spouse dies, assets are allocated to the credit shelter trust up to the applicable exclusion amount. Choosing which assets go into the trust calls for analysis of basis, growth potential and income production.
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Administration during the surviving spouse’s lifetime
The trustee manages the trust assets and makes distributions to the surviving spouse under the trust terms. The survivor generally enjoys the income and may receive principal as needed for health, education, maintenance and support. The trust assets are not included in the surviving spouse’s gross estate.
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Distribution at the second death
When the surviving spouse dies, the credit shelter trust assets pass to the remainder beneficiaries, typically the children, without estate tax in the survivor’s estate. The growth in the trust assets between the first and second deaths also escapes estate tax.
Benefits Beyond the Tax Savings
A credit shelter trust does more than save estate tax. Properly structured trust assets are generally protected from creditors of the surviving spouse and of the beneficiaries. If the surviving spouse remarries, the trust assets stay dedicated to the original beneficiaries, so the children’s inheritance is protected. The trust can be drafted to allocate generation-skipping transfer tax exemption, which adds tax savings for grandchildren.
A corporate or professional trustee can supply investment expertise and impartial administration. Trust administration generally avoids the publicity of probate, and the trust gives continuity of management for assets that will benefit more than one generation.
Drafting Considerations
An effective credit shelter trust turns on a handful of technical choices.
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Trustee selection
The surviving spouse may serve as sole trustee with appropriate restrictions, as co-trustee with an independent trustee, or not at all. Each option carries different tax and practical consequences. An independent trustee may be necessary when broader distribution powers are wanted without causing estate inclusion.
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Distribution standards
The standards governing distributions to the surviving spouse must balance flexibility against tax efficiency. The “ascertainable standard” of health, education, maintenance and support (HEMS) is commonly used because it permits substantial distributions without causing inclusion in the surviving spouse’s estate.
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Powers of appointment
A limited power of appointment lets the surviving spouse adjust the ultimate disposition of trust assets among descendants without estate tax inclusion. A general power of appointment, by contrast, would defeat the trust’s tax purpose.
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Formula clauses
Most credit shelter trusts are funded under formula clauses tied to the applicable exclusion amount. Because the federal and New York exclusions differ and change over time, the formula has to be drafted with precision so that it produces the intended result under varying tax conditions.
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Coordination with other planning tools
Credit shelter trusts often work alongside marital trusts, qualified terminable interest property (QTIP) trusts, irrevocable life insurance trusts (ILITs) and other vehicles, and the pieces have to fit together.
When a Credit Shelter Trust Makes Sense
Credit shelter trusts are not right for every family. They are typically most useful in the following situations.
| Situation | What the trust does |
|---|---|
| The couple’s combined estate exceeds, or may come to exceed, the New York estate tax exclusion | Uses the first spouse’s exclusion so that both exclusions are fully used and the survivor’s estate stays below the cliff |
| The couple wants to provide for the surviving spouse while preserving assets for the children | Gives the survivor income and support while the principal is held for the remainder beneficiaries |
| Creditor protection or a future spouse is a concern | Keeps the assets out of the survivor’s own name and dedicated to the original beneficiaries |
| The couple holds appreciating assets | Removes future growth from the survivor’s taxable estate |
| Multi-generational planning, including generation-skipping transfers, is desired | Allows GST exemption to be allocated to the trust for grandchildren |
Drawbacks and Trade-Offs
A complete analysis also weighs the disadvantages. Assets held in a credit shelter trust receive a step-up in basis only at the first death, not at the second, whereas assets passing outright to a surviving spouse and then to the children receive a step-up at both deaths. For a family whose estate may never exceed the federal exclusion, the income tax cost of the lost second step-up can outweigh the estate tax savings. For New York residents facing the state estate tax cliff, the trade-off usually still favors the trust.
The trust requires ongoing administration: separate tax filings, recordkeeping and trustee oversight. Most families find these costs modest next to the tax saved. And once established at the first death, the trust is generally irrevocable; the surviving spouse does not have unrestricted access to the assets and must work within the trust’s terms.
Modernizing an Existing Credit Shelter Trust
Many New York couples set up credit shelter trusts years or decades ago, when exemptions were much lower. Those trusts may no longer fit current circumstances or current law. New York offers several ways to update them.
| Tool | How it works |
|---|---|
| Decanting | New York’s decanting statute allows a trustee to transfer assets from one trust to another with improved terms, under specified conditions |
| Trust modification proceeding | A court-supervised modification can address outdated provisions |
| Nonjudicial settlement agreement | In some cases the beneficiaries and trustees can agree to changes without court involvement |
| Disclaimer | A strategic disclaimer can sometimes redirect assets to reach a better result under current law |
How the Planning Process Works
We begin with a consultation about your family circumstances, current estate plan and objectives, then review your assets, valuations and projected estate tax exposure under current law. We present the planning options, including credit shelter trust structures and alternatives. Once a plan is chosen, we draft the trust documents, wills, powers of attorney and health care directives, oversee execution and advise on retitling assets where needed. We recommend reviewing the plan every few years and after significant life events or changes in the law. When a credit shelter trust has to be funded after a spouse’s death, we guide the family through the administration.
Talk to Us About Credit Shelter Trust Planning
With New York’s estate tax cliff and the absence of portability, a couple that does not plan can cost its heirs hundreds of thousands of dollars or more. If you want to know whether a credit shelter trust fits your family, or you are a surviving spouse or trustee who has to fund and run one, call us at 212-233-1233 or email [email protected].
