Transfers between spouses are not taxed, but taxes are imposed on a transfer to anyone else — even your children — of any amount in excess of the estate tax exemption, whether that amount is either $3.5 million, $5 million, or $11.7 million.
A transfer of assets by the first spouse to die to the surviving spouse may not have tax consequences if all assets are distributed to the surviving spouse. But once the surviving spouse passes away, the tax burden can be unnecessarily excessive.
For example, if Congress passes Sanders’s For the 99.5% Act, and a surviving spouse dies with a $7 million estate, the most her estate can protect from being taxed is $3.5 million. Unless the surviving spouse timely claims “portability” of the exemption not used by first spouse to die, the other $3.5 million would be taxed at 45% — meaning, a $1,575,000 tax payment would be made to the IRS.
There is a way to avoid taxation entirely if the spouses plan together when both are living. They can establish a Credit Shelter Trust (CST), which is also known as a bypass, family, or exemption trust.
Under this plan, each spouse establishes his/her own separate trust. In each separate trust, each spouse further divides their trust assets between a marital share and a family share. The family share of each trust (up to the entire estate tax exemption) is then “sheltered” in the family trust portion of the trust, while the remainder is held in trust for — or distributed outright to — the surviving spouse, who will not be taxed on any transfers from the deceased spouse.
Because assets placed in the family trust are separated from the surviving spouse’s estate, the assets in the surviving spouse’s estate can pass estate tax free to the beneficiaries at the death of the surviving spouse, so long as the estate’s assets total less than the estate tax exemption.
Accordingly, given the example above of a married couple with $7 million under the For the 99.5% Act, there will be no tax. How so? Because $3.5 million will be sheltered from estate tax by using the first spouse to die’s estate tax exemption, and the remaining assets will be protected by the surviving spouse’s estate tax exemption.