If you are married and the value of your estate combined with that of your spouse's estate goes over the tax exemption provided by the federal government, a credit shelter trust might lower your inheritance taxes. By using a credit shelter trust, each spouse is able to use their full, individual estate tax exemption, which in practice, doubles the allowed exemption.

Take for an example two married people with $3,000,000 in assets that they want to leave to one another if either should pass away. Upon one spouse's death, assets pass to the widow or widower tax-free. However, the surviving spouse will then have an estate valued at $3,000,000. When the second spouse eventually passes away, heirs would be charged estate tax on the amount which exceeds the exemption (in 2005, that amount would be $1,500,000, taxed at a combined rate of 34.58%).

The beneficiaries of a credit shelter trust are typically the deceased spouse's other heirs - usually the children. If $1,500,000 is placed in the credit shelter trust by the first spouse, those assets will be granted to the children tax-free. As an added bonus, the widow or widower can have a life estate in those assets. This means that the surviving spouse can use the assets and whatever income they produce as long as he or she is alive. The surviving spouse can even use the principal for heath and maintenance.

Upon the passing of the second spouse, the remainder of the couple's estate ($1,500,000 in this example) would fall below the exemption. Therefore, the estate would not owe any tax on what is left behind.

Due to the estate tax's uncertain future-the exact rate, whether or not it will be repealed and so on-many credit shelter trusts are discretionary. Here's what that means: after the first spouse has passed away, the survivor can choose to disclaim, or decline, any or all assets left to him or her. Everything that is disclaimed (up to the estate tax exemption limit) then would go to the credit shelter trust.

If you set up a mandatory credit shelter trust, upon your passing, the assets you leave behind would automatically be placed into the trust. The surviving spouse would not have any ability to choose between assets or base a decision about what should go into the trust based on current tax laws.

LegalZoom is not a lawfirm and can only provide self-help services at your specific direction. Information contained above is subject to change and is not applicable to every state. Visit LegalZoom.com for specific state-by state-documents.

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