Credit Shelter Trust (CST)

A Credit Shelter Trust is designed to allow affluent couples to reduce or completely avoid estate taxes when passing assets on to heirs, typically the couple's children. This type of irrevocable trust is structured so that upon the death of the trust's creator or settler, the assets specified in the trust agreement and the income they generate are transferred to the settlor's spouse. 

However, a key benefit to this type of trust is that the surviving spouse maintains certain rights to the trust assets during the remainder of his or her lifetime. Under specific circumstances such as the need to fund certain medical or educational expenses, the surviving spouse can tap into the trust's principal and not just the income. And upon the surviving spouse's death, the trust's assets are transferred to the remaining beneficiaries without any estate taxes levied.

Credit shelter trusts are created upon a married individual's death and funded with that person's entire estate or a portion of it as outlined in the trust agreement. These assets then flow to the surviving spouse. But because the trust is managed by a designated trustee, the surviving spouse never actually takes control of the trust's assets. Therefore, the transfer does not add to the surviving spouse's taxable estate. Credit shelter trusts are also known as AB Trusts or Bypass Trusts. This is because CSTs are essentially bypass trusts in which each spouse has a separate "taxable" estate. These estates are known as A trust and B trust.

Credit shelter trusts are designed so that couples can take full advantage of estate tax exemptions. The estate, gift, and generation-skipping transfer tax (GSTT) exemption currently stands at a $10 million base for individuals and $20 million base for couples until December 31, 2025 — considering Congress doesn't drastically update the Tax Cuts and Jobs Act until then. 

Suppose a husband and wife who have been married for several years each accumulates an estate worth $6 million and the husband sets up a credit shelter trust to be funded upon his death with his share of their combined estate. After the husband dies, his $6 million estate and any income it generated passes estate-tax free onto his wife because it falls below the federal exemption.

However, the transfer boosts the wife's net income to $12 million and past the estate-tax exemption. But because these assets were held in the trust outside of her control, her taxable estate is still valued at $6 million and still within the estate-tax exemption. Thus, she can pass on her assets to her children estate-tax free when she dies.