Pros and Cons of Credit Shelter Trusts
Credit shelter trusts come with both advantages and trade-offs. On the plus side, they offer the surviving spouse added protection from creditors. However, the surviving spouse does not have unrestricted access to the trust assets, which may be a drawback for some families. Additionally, these trusts involve ongoing administrative responsibilities and costs. For example, the trustee must file an annual Form 1041 income tax return for the trust.
It’s also important to consider that assets held in a credit shelter trust do not receive a second step-up in basis at the death of the surviving spouse. As a result, the next generation may face higher capital gains taxes when those assets are eventually sold, potentially offsetting the estate tax savings. Families should weigh the benefits of reducing estate tax through a credit shelter trust against the potential loss of a second basis step-up and the associated capital gains implications for heirs.
In addition, families should be thoughtful about which assets are best suited for funding a credit shelter trust. Funding the trust with income-producing assets can provide ongoing support to the surviving spouse, while allowing assets expected to appreciate significantly to remain in the surviving spouse’s estate and benefit from a second step-up in basis. Alternatively, in cases where future estate tax exposure is a concern, it may make sense to place highly appreciating assets in the trust to prevent further growth within the surviving spouse’s taxable estate.
Old Credit Shelter Trusts
It’s important for families to periodically review and update their estate planning documents to reflect changes in tax laws and evolving planning strategies. For instance, prior to 2014, New York’s estate tax exemption was just $1 million. Many older documents drafted during that time direct the full exemption amount to a credit shelter trust, which could now result in the trust being overfunded since the exemption is now much larger. Including language that gives the surviving spouse discretion to determine the amount allocated to the trust can provide greater flexibility and help avoid unintended tax consequences.
Disclaimer Trusts
Another strategy to reduce New York estate tax for a high-net-worth surviving spouse is the use of a “disclaimer trust.” Under this approach, estate documents can be drafted to allow all assets to pass to the surviving spouse using the unlimited marital deduction available to U.S. spouses. However, the surviving spouse may choose to “disclaim” a portion of the inheritance allowing those assets to instead pass into an irrevocable trust for the benefit of the couple’s children. It should be noted that the spouse must do so within nine months of the first spouse’s death.
To preserve the validity of the disclaimer, the surviving spouse must not take possession or control of the disclaimed assets. It is also essential to carefully assess the surviving spouse’s current and projected financial needs to ensure they retain sufficient resources. A strategy that saves on estate taxes but leaves the surviving spouse underfunded could lead to serious hardship. Like credit shelter trusts, disclaimer trusts do not receive a second step-up in basis at the second spouse’s death. Therefore, any potential estate tax savings should be weighed against the possibility of higher capital gains for the next generation.
Clayton Trust
An alternative to using disclaimer trusts for minimizing New York estate tax is a Clayton trust. This structure gives the executor the authority and flexibility to determine how much of the estate should be allocated to a credit shelter trust versus a qualified terminable interest property (QTIP) trust. Assets placed in the credit shelter trust are excluded from estate taxation at the death of both spouses, while the QTIP trust provides income access for the surviving spouse. By granting the executor discretion over the allocation, the burden of post-mortem estate tax planning is shifted away from the surviving spouse.
Santa Clauses
For estates just above New York’s 105% estate tax cliff, charitable giving can be a highly effective strategy and can sometimes reduce the estate tax by more than the actual amount donated. As an example, a $7.6 million estate would be liable for an estate tax bill of $718,800, but a donation to charity of $440,000 reduces the tax bill to $0. A clause in the estate documents could take effect during this type of situation.
Gifting Strategies for Families above the Exemption
While strategies such as disclaimers, credit shelter trusts, Clayton Trusts, “Santa Clause” provisions, and asset equalization can be highly effective for families with estates in the $5 million to $14 million plus range, families with significantly higher net worth may need to adopt more aggressive lifetime gifting strategies to reduce their estates below the combined New York estate tax exemption thresholds. Families should take advantage of the annual gift tax exclusion, which is $19,000 per donor per recipient in 2025. For example, a couple with three married children and five grandchildren could gift up to $418,000 annually by giving the full exclusion amount to each family member. This strategy can meaningfully reduce the size of their taxable estate and help bring it below exemption thresholds.
We often recommend that families consider making smaller gifts during their lifetime rather than through their will. Lifetime gifts not only allow recipients to benefit sooner, but they also avoid the possibility of revealing the full contents of the will. Additionally, families may want to accelerate gifting during market downturns or when asset values are temporarily depressed, as this can maximize the impact of both the annual gift exclusion and the lifetime exemption through strategic timing.
If the annual gift exclusion alone isn’t sufficient to meaningfully reduce a family’s taxable estate, a range of alternative gifting strategies may be appropriate, depending on the family’s goals, financial profile, and market conditions. One option is to make outright gifts using the lifetime federal estate and gift tax exemption, currently set at $13.99 million. Families with ongoing charitable giving goals might explore a charitable lead trust (CLT) to reduce their taxable estate, while those wishing to make significant charitable gifts in the future, while also retaining income in the meantime, may benefit from a charitable remainder trust (CRT). Although New York State does not impose a gift tax, gifts exceeding the annual exclusion amount must be reported on IRS Form 709, which also initiates the IRS statute of limitations.
It should be noted that interest rates often play a key role in determining which gifting strategies are most effective. In a high interest rate environment, structures like charitable remainder trusts (CRTs) and qualified personal residence trusts (QPRTs) tend to be more advantageous. Conversely, low interest rate environments generally favor strategies such as grantor retained annuity trusts (GRATs) and intentionally defective grantor trusts (IDGTs). In either case, wealthy families are often best served by implementing these strategies proactively, particularly in New York, where gifts made within three years of death may be pulled back into the estate under the state’s claw back rule.
It’s also important to consider the individual circumstances and tax profiles of the recipients when deciding which assets to transfer. For instance, it is typically more tax-efficient for a lower-income beneficiary to receive income-generating assets or those with large unrealized capital gains, while high-income recipients may benefit more from receiving tax-exempt assets like municipal bonds.
