With the credit shelter trust, the first spouse who dies fully utilizes his or her unified credit by transferring assets to the trust in any amount up to the maximum unified credit (also known as the lifetime exemption) amount. Once in the trust, the assets are managed by the trustee for thebenefit of the surviving spouse, who is eligible to receive all the net income from the trust and certain restricted principal distributions. Uponthe death of the surviving spouse, the assets then pass to the heirs tax free. (Please note that if both spouses have assets of their own, theyshould each establish a credit shelter trust.)Individuals who don’t take advantage of the credit shelter trust could end up with heirs who pay very large estate taxes. Take, for instance, thehusband with an estate worth $3 million who decided to make use of the unlimited marital deduction instead of the credit shelter trust. (Theunlimited marital deduction allows for an unlimited amount of assets to pass between spouses, inter vivos or testamentary (during life or at death), without incurring any gift tax consequences.) Upon his death, heleft all of his assets to his wife and had an estate worth zero and no estate tax liability. However, upon his wife’s death, the full value of theestate passed to her from her husband was included in her estate and her children had a very large estate tax to pay.

If the husband had used the credit shelter trust instead, $650,000 (the 1999 maximum lifetime exemption amount) would have been removed from the husband’s estate at his death; the assets would have been used for the benefit of the spouse for her lifetime; the $650,000 (and any amount of appreciation in the assets) would not have been included in the wife’s estate at her death; and the assets, no matter what value they had grown to during the life of the surviving spouse, would have passed to the heirs without any estate tax consequences. (Please note: for married couples,the combined lifetime exemption in 1999 is $1.3 million.)Now, you’re probably asking yourself, what about the rest of the husband’s assets-the other $2,350,000? Can these assets also go into a trust for the benefit of the surviving spouse? Yes, and that trust is called a marital deduction trust.

Combining the credit shelter trust with a marital trust allows the decedent spouse to utilize his/her unified credit to benefit the surviving spouse, and eventually his/her children. It also allows the decedent spouseto pass assets in excess of the unified credit to his/her spouse in a trust that will qualify the assets for the unlimited marital deduction. (Theunlimited marital deduction allows spouses to transfer an unlimited amount of assets between themselves, during lifetime or at death, with no transfer taxes.)The assets in the marital trust, over which the surviving spouse has full control of both principal and income as well as the disposition of the assets upon his/her death, are fully includible in the surviving spouse’s estate. To reduce the surviving spouse’s estate upon death, assets in themarital trust should be used for the benefit of the surviving spouse before assets in the credit shelter trust. For this reason, it’s important to choosecarefully when allocating assets between the two trusts.

Assets expected to appreciate significantly should fund the credit shelter trust, because the value of the assets and any appreciation of the assets in that trust are not included in the surviving spouse’s estate, and will provide some growth as the assets will eventually go to the heirs. Thebalance of the assets should fund the marital trust.

Couples can also choose to qualify the assets in the marital trust for special treatment by considering the assets Qualified Terminable Interest Property (QTIP). The QTIP Marital Trust, funded at the death of the firstspouse, is available to support the surviving spouse by providing him/her with income from the trust and a limited right to withdraw principal. Thespouse, however, does not have control in disposing of the assets at his/her death like he/she does in a non-QTIP Marital Trust. Therefore, theassets will be distributed at the second spouse’s death per the wishes of the first decedent spouse. This ensures the first spouse that assets willgo to his/her heirs and not be controlled by the surviving spouse. ThisQTIP Marital Trust is often used by couples when one or both spouses have children from a previous marriage.

(Alan S. Moore is a financial advisor of Legg Mason Wood Walker, Inc., adiversified investment brokerage and financial services firm in New Orleans.)

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