For many years, the state of New Jersey imposed an estate tax on estates with a gross value greater than $675,000. Given the fact that the populous of New Jersey is one of the wealthiest in the nation and that the threshold for the tax was quite low ($675,000), many estates in New Jersey were subject to the estate tax.
For this reason, I assisted many clients in attempting to avoid or reduce the impact of the New Jersey estate tax on their estates. The common technique that was employed to eliminate or reduce the estate tax was a “credit shelter trust” drafted into the last wills and testaments of a married couple.
Credit shelter trusts worked as follows: Mr. and Mrs. Smith had an estate worth $1,000,000. Their estate was comprised of a house worth $500,000 and a joint brokerage account worth $500,000. Since the Smith’s estate exceeded $675,000, the estate would have been subject to the New Jersey estate tax. The Smith’s estate would have paid approximately $32,000 in estate tax upon the death of the second spouse.
Since the tax was not imposed on transfers to a spouse, no tax would have been imposed if Mr. Smith died leaving his entire estate to Mrs. Smith; however, when Mrs. Smith died with $1,000,000, her estate would have paid estate tax on the $325,000 by which her estate exceeded the $675,000 threshold.
Credit shelter trusts were designed to utilize the credit that both Mr. and Mrs. Smith received against the estate tax. In other words, both Mr. Smith and Mrs. Smith received a credit of $675,000 against the New Jersey estate tax. If Mr. Smith simply devised his entire estate to Mrs. Smith, there would be no estate tax when Mr. Smith died, but by leaving everything to the surviving spouse, Mr. Smith’s estate was failing to utilize his $675,000 credit against the estate tax.
If Mr. Smith devised up to $675,000 of his estate to someone or something other than Mrs. Smith (his surviving spouse), his estate would use some or all of his $675,000 credit against the estate tax. This is where the credit shelter trust came into play. Mr. and Mrs. Smith wanted to benefit the surviving the spouse. They didn’t want to leave their assets to anyone other than the surviving spouse, but they also wanted to minimize the estate tax as best they could.
A credit shelter trust was a trust drafted into the Wills of Mr. and Mrs. Smith. Such a trust is called a testamentary trust because it is a trust in a last will and testament. The trust is for the benefit of the surviving spouse during her life. When she dies, the money in the trust would pass to the couple’s children.
The Smith’s assets would then be divided so that Mr. Smith owned half the house and Mrs. Smith owned the other half of the house. Similarly, the Smith’s brokerage account would be divided so that each spouse owned half the account.
When Mr. Smith died, half the house and half the brokerage account would pass to the credit shelter trust. Half the total assets would have been worth $500,000. The trust would be for the benefit of Mrs. Smith and Mrs. Smith would be the trustee of the trust, so Mrs. Smith would have almost unfettered access to the assets in the trust to use for her benefit.
By doing this, Mr. Smith’s estate would use $500,000 of his $675,000 credit against the estate tax. When Mrs. Smith died, her estate would only be worth $500,000, which is less than $675,000. Instead of paying $32,000 in estate tax, the Smith’s estate would pay no estate tax.
This was a great technique that I drafted into hundreds of Wills for my clients. The thing is, now that the estate tax has been eliminated, this technique is no longer beneficial and is probably more complicated than most clients need, so I would recommend that these clients have their Wills revised to eliminate this (now antiquated) planning technique.