Asset protection planning often continues after death, especially when a surviving spouse has judgements or is vulnerable to lawsuit. The design of your estate planning determines whether your assets will be vulnerable to creditors of your surviving spouse or children.
The typical living trust based estate plan for married couples the first spouse to die has left all their assets to a surviving spouse. If a judgment exists, or subsequently is entered, against the surviving spouse the inherited assets are at risk. A better solution is to leave assets in trust.
There are other issues when you consider estate tax. The way to avoid estate tax at the first death in a marriage is for the decedent to put his assets in a marital trust that escapes estate tax by the unlimited marital deduction. But, the marital deduction requires that all trust income must be distributed to the surviving spouse. That requirement would permit a creditor to garnish the income and compel its distribution. If the first spouse puts the surviving spouse’s inheritance in a credit shelter trust the inheritance still avoids estate tax by the approximately $5.4 million estate tax credit but there is no requirement to distribute income or principal from the credit trust. All distributions can be made at the surviving spouse’s sole discretion, and the trust would include a spendthrift provision to protect the assets from creditors.
There is another issue: income tax. An advantage of marital trust bequests is that the assets left to the surviving spouse receive a stepped-up tax basis so the surviving spouse owes no income tax if the assets were sold shortly after the first death. There would be a second basis increase when the surviving spouse dies and the children inherit the property. The children do not receive the second basis step up when they inherit assets from a credit shelter trust.
Page last updated on May 22, 2020