Credit Shelter Trust: The Cornerstone of Vermont Estate Tax Planning for Married Couples
Vermont does not allow portability. When the first spouse dies, their $5,000,000 Vermont estate tax exemption either gets used or it is gone forever. A Credit Shelter Trust, also called a Bypass Trust or A/B Trust, is the legal structure that uses it, protecting hundreds of thousands of dollars in potential Vermont estate tax by ensuring that neither spouse's exemption is wasted.
What Is a Credit Shelter Trust?
A Credit Shelter Trust, commonly called a Bypass Trust or A/B Trust, is an irrevocable trust established at the first spouse's death that holds an amount up to the applicable estate tax exemption. The trust uses the deceased spouse's exemption at the first death rather than allowing that exemption to be wasted when assets pass outright to the surviving spouse under the unlimited marital deduction.
When everything passes outright to the surviving spouse, the entire combined estate ends up in the survivor's hands with only one exemption left to protect it. In Vermont, that means a couple with a $10,000,000 combined estate that leaves everything to the survivor faces $800,000 in Vermont estate tax at the second death, tax that a properly structured Credit Shelter Trust would have eliminated entirely.
A Credit Shelter Trust is the cornerstone of Vermont estate tax planning for married couples, and for good reason. It is the primary mechanism for using both spouses' Vermont exemptions rather than wasting the first to die's exemption. For a detailed illustration of the math, including a side-by-side comparison of estates with and without a Credit Shelter Trust, see our dedicated Vermont Estate Tax page.
Vermont has no portability. The first spouse's $5,000,000 Vermont exemption either gets used at the first death through a Credit Shelter Trust or a direct bequest to non-spouse beneficiaries, or it is permanently lost. There is no Vermont portability election and no second chance after the first death.
The A/B Trust Structure
The A/B Trust structure divides a married couple's estate into two components at the first death. Understanding how each component works is essential to understanding how the Credit Shelter Trust achieves its estate tax savings.
The A Trust: Marital Trust or QTIP Trust
The A Trust, also called the Marital Trust or Qualified Terminable Interest Property (QTIP) Trust, receives the portion of the deceased spouse's estate that exceeds the applicable exemption amount. Assets in the A Trust qualify for the unlimited marital deduction, meaning no estate tax is owed on them at the first death. The surviving spouse is typically entitled to all income from the A Trust during their lifetime and may have access to principal as well. At the surviving spouse's death, the A Trust assets are included in their taxable estate and subject to Vermont and federal estate tax at that time.
The A Trust defers estate tax; it does not eliminate it. The tax on A Trust assets is simply postponed from the first death to the second. The marital deduction that shelters A Trust assets at the first death does not protect them at the surviving spouse's death.
The B Trust: Credit Shelter Trust or Bypass Trust
The B Trust, which is the Credit Shelter Trust itself, receives an amount up to the deceased spouse's applicable estate tax exemption. In Vermont, this means up to $5,000,000 at the Vermont level and up to the applicable federal exemption at the federal level. Because the B Trust is funded with an amount within the exemption, no estate tax is owed on it at the first death.
The B Trust's assets bypass the surviving spouse's taxable estate. When the surviving spouse dies, the B Trust assets are not included in their estate for Vermont or federal estate tax purposes. They pass to the trust's remainder beneficiaries, typically the couple's children, free of estate tax at the second death. The first spouse's exemption has been used at the first death, and the assets sheltered by that exemption are permanently protected from estate tax at every subsequent death.
The surviving spouse can still benefit from the B Trust during their lifetime. The trust can be structured to provide income to the surviving spouse, access to principal for health, education, maintenance, and support, and other benefits specified by the deceased spouse in the trust document. The key is that the surviving spouse's interest in the B Trust is a beneficial interest, not outright ownership, which is what keeps the assets outside the survivor's taxable estate.
How a Vermont Credit Shelter Trust Works — Illustration
The diagram below illustrates how the Credit Shelter Trust structure routes assets at the first death to use both spouses' Vermont exemptions, passing $10,000,000 to children entirely free of Vermont estate tax.
Why the Credit Shelter Trust Is Especially Important in Vermont
The Credit Shelter Trust is important for every married couple with estate tax exposure, but it is particularly critical for Vermont couples because of Vermont's no-portability rule.
Vermont Has No Portability
Under federal law, when the first spouse dies, the surviving spouse can elect to use the deceased spouse's unused federal estate tax exemption. This is called portability. If the first spouse does not use their federal exemption because everything passes to the survivor under the marital deduction, the survivor can use the deceased spouse's exemption at their own death.
Vermont does not have portability. Vermont's $5,000,000 exemption is available to each individual, but it cannot be transferred to the surviving spouse. If the first spouse dies and leaves everything outright to the survivor, the first spouse's Vermont exemption is permanently and irrevocably lost. The surviving spouse has only their own $5,000,000 Vermont exemption to protect the entire combined estate.
The Cost of Not Planning
A Vermont couple with a combined estate of $10,000,000 who leaves everything to the survivor and does not use a Credit Shelter Trust faces the following outcome. At the first death, no Vermont estate tax is owed because the assets pass to the surviving spouse under the unlimited marital deduction. But the first spouse's $5,000,000 Vermont exemption is permanently wasted. At the surviving spouse's death, they have a $10,000,000 estate and only their own $5,000,000 Vermont exemption. Vermont estate tax is owed on $5,000,000 at 16%, which is $800,000.
With a Credit Shelter Trust in place, $5,000,000 flows into the B Trust at the first death, using the first spouse's Vermont exemption. No Vermont estate tax is owed at the first death. At the surviving spouse's death, the B Trust assets are outside their estate, and the survivor's own $5,000,000 Vermont exemption covers their remaining estate. Vermont estate tax at the second death: $0. Vermont estate tax saved: $800,000.
Vermont Estate Tax Comparison — $10,000,000 Combined Estate
WITHOUT a Credit Shelter Trust: Vermont estate tax at second death = $800,000 (16% × $5,000,000 above threshold).
WITH a Credit Shelter Trust: Vermont estate tax at second death = $0. Both $5,000,000 Vermont exemptions used. $800,000 saved.
For a complete side-by-side comparison with a detailed step-by-step illustration, see our Vermont Estate Tax page.
What the Surviving Spouse Can Receive From the Credit Shelter Trust
A common concern about the Credit Shelter Trust is whether the surviving spouse is adequately provided for after the first death. The answer is that the trust can be structured generously for the surviving spouse's benefit while still keeping the assets outside their taxable estate.
• All income: The trust can be structured to pay the surviving spouse all income generated by the trust's assets during their lifetime.
• Principal for health, education, maintenance, and support: The trust can authorize distributions of principal to the surviving spouse for their health, education, maintenance, and support, commonly referred to as the HEMS standard.
• Five-and-five power: The trust can give the surviving spouse the right to withdraw the greater of $5,000 or 5% of the trust's assets annually, providing direct access to a defined amount of principal each year.
• Broader discretionary distributions: In some cases, the trust can give the trustee discretion to make additional distributions to the surviving spouse based on their needs and circumstances.
What the trust cannot do, while still keeping the assets outside the surviving spouse's taxable estate, is give the surviving spouse a general power of appointment over the trust's assets, which would cause those assets to be included in the survivor's estate. We structure the trust's distribution provisions carefully to ensure that the surviving spouse is well provided for while the estate tax protection remains intact.
Credit Shelter Trust vs. QTIP Trust
The terms Credit Shelter Trust, Bypass Trust, and A/B Trust all refer to the same instrument: the B Trust structure that holds assets up to the applicable exemption and shelters them from estate tax at both deaths. The QTIP Trust is a different but related instrument.
A Qualified Terminable Interest Property (QTIP) Trust is used for the A Trust component of an A/B structure. It provides income to the surviving spouse during their lifetime while directing the underlying assets to the deceased spouse's chosen beneficiaries at the survivor's death. This structure is particularly useful for blended families, where the first spouse wants to provide for the surviving spouse but ultimately direct assets to their own children rather than to the survivor's estate or the survivor's subsequent spouse.
A QTIP Trust qualifies for the unlimited marital deduction, so no estate tax is owed at the first death on A Trust assets. At the surviving spouse's death, the QTIP assets are included in the survivor's estate and subject to estate tax at that time. The QTIP defers rather than eliminates the tax on A Trust assets, which is why its proper coordination with the Credit Shelter Trust is essential for maximizing estate tax savings.
Frequently Asked Questions: Credit Shelter Trusts in Vermont
Does Vermont allow portability of the estate tax exemption between spouses?
No. Vermont does not recognize portability. A surviving spouse cannot use a deceased spouse's unused Vermont estate tax exemption. Vermont's $5,000,000 exemption must be used at each spouse's death through proper planning, or it is permanently lost. This makes the Credit Shelter Trust the most important estate tax planning instrument for married Vermont couples with combined estates above $5,000,000.
When is the Credit Shelter Trust funded?
The Credit Shelter Trust is established in the estate plan documents during the spouses' lifetimes but is funded at the first spouse's death. The trust becomes operative and receives its assets at that time, typically through the estate plan's distribution provisions. For the trust to work as intended, the first spouse's estate must have assets in their individual name or subject to their disposition at death; a surviving spouse cannot fund the trust on behalf of the deceased spouse.
Can the Credit Shelter Trust be included in a revocable living trust?
Yes, and this is the most common and effective approach. Most comprehensive estate plans for Vermont married couples include a revocable living trust with built-in Credit Shelter Trust provisions that take effect at the first spouse's death. The revocable living trust avoids probate and provides incapacity planning during the spouses' lifetimes; the Credit Shelter Trust provisions within it activate at the first death and use the deceased spouse's Vermont and federal exemptions. This combined structure is the foundation of most Vermont married couple estate plans.
What happens to the Credit Shelter Trust at the surviving spouse's death?
At the surviving spouse's death, the Credit Shelter Trust terminates and its assets pass to the remainder beneficiaries designated by the first spouse in the trust document, typically the couple's children or grandchildren. Because the Credit Shelter Trust assets were never included in the surviving spouse's taxable estate, they pass to the remainder beneficiaries free of Vermont and federal estate tax at the second death. The first spouse's exemption, used at the first death, permanently protects those assets from estate tax at every subsequent generational transfer.
Can the Credit Shelter Trust also be a GST trust?
Yes, and for many families it should be. A Credit Shelter Trust that is also funded with the deceased spouse's federal generation-skipping transfer (GST) tax exemption becomes a dual-purpose trust: it shelters assets from estate tax at the surviving spouse's death and from GST tax on subsequent distributions to grandchildren and more remote descendants. This dual allocation, made properly on the estate tax return, is one of the most powerful and cost-effective multi-generational estate tax planning steps available.
What if we already have simple “I love you” wills that leave everything to each other?
Reciprocal or “I love you” wills that leave everything outright to the surviving spouse are a very common estate planning starting point, but they do not use a Credit Shelter Trust and do not protect the first spouse's Vermont exemption from being permanently lost. Every Vermont couple with a combined estate above $5,000,000 should have their existing estate plan reviewed and updated to include Credit Shelter Trust provisions. The cost of the update is modest compared to the $800,000 or more in Vermont estate tax that a properly structured plan would save.
Does a Credit Shelter Trust require a separate legal document?
No. The Credit Shelter Trust is typically established as a provision within the couple's revocable living trust or will rather than as a separate standalone document. It comes into existence and is funded at the first death. The trust document drafted during the spouses' lifetimes contains all the terms governing the Credit Shelter Trust's operation, distribution standards, trustee selection, and ultimate disposition of assets.
Creating a Credit Shelter Trust in Vermont
A Credit Shelter Trust requires careful drafting to ensure that the distribution provisions satisfy IRS requirements, that the surviving spouse is adequately provided for within the boundaries that preserve the trust's estate tax protection, and that the trust is properly coordinated with the rest of the estate plan. The trust's terms must comply with both Vermont and federal law, and the funding mechanism must be structured to ensure that the first spouse's estate has sufficient assets to fund the trust at death.
At Will and Trust Planning, a Credit Shelter Trust is a standard component of virtually every estate plan we prepare for Vermont married couples with combined assets above $5,000,000. Before we draft a single document, we sit down with you in a Peace of Mind Planning Session to assess your Vermont and federal estate tax exposure, explain the Credit Shelter Trust structure in plain language, and build a plan that uses both spouses' exemptions effectively.
Contact Will and Trust Planning Today
For personalized advice on estate planning, including strategies to minimize or avoid probate, contact Will and Trust Planning today. Our experienced estate planning attorneys can help you understand your options, draft essential documents, and create a plan that protects your assets and achieves your goals.