A credit trust is an irrevocable trust that a married couple builds into their estate plan to preserve the first spouse’s federal estate tax exemption when that spouse dies. Assets up to the exemption amount flow into the trust, sit outside the surviving spouse’s taxable estate for the rest of their life, and pass to the couple’s chosen beneficiaries free of estate tax when the surviving spouse eventually dies. For 2026, the federal estate tax exemption is $15 million per individual, so a married couple using credit trust planning can shelter up to $30 million from estate tax when both exemptions are fully used.1Internal Revenue Service. What’s New – Estate and Gift Tax
How a Credit Trust Works
The same structure goes by three names: credit trust, bypass trust, and credit shelter trust. You’ll also see it called the “B” trust in an AB trust arrangement. The terms are interchangeable.
The trust is drafted into a revocable living trust or will while both spouses are alive, but it doesn’t exist as a separate legal entity yet. It springs into existence, irrevocably, only when the first spouse dies.2Legal Information Institute. Bypass Trust
To understand why the trust exists at all, start with the alternative. Everything the first spouse owns can pass to the surviving spouse tax-free under the unlimited marital deduction.3Office of the Law Revision Counsel. 26 USC 2056 – Bequests, Etc., to Surviving Spouse That sounds efficient, but it wastes the deceased spouse’s personal exemption, which is otherwise lost. The entire combined estate then sits in the survivor’s name and later gets measured against only one exemption. Any excess is taxed at 40%.
Every individual has an exemption, technically called the applicable exclusion amount, that shields a certain dollar value from the federal estate tax through the unified credit.4GovInfo. 26 USC 2010 – Unified Credit Against Estate Tax A credit trust captures the first spouse’s exemption by diverting assets up to that amount into a trust that bypasses the surviving spouse’s estate. Those assets, and anything they grow into, stay outside the survivor’s taxable estate permanently.
Funding Happens After the First Death
Nothing happens automatically. When the first spouse dies, the executor or successor trustee has to value the estate and move assets into the credit trust according to a formula written into the document.
For estates large enough to require it, that means filing IRS Form 706 within nine months of the date of death.5Internal Revenue Service. Instructions for Form 706 The trustee then retitles the chosen assets out of the deceased spouse’s name and into the credit trust.
Which assets go in matters. Property expected to appreciate significantly is often the first choice, because all future growth inside the trust stays outside the surviving spouse’s taxable estate. A $2 million position that grows to $8 million never touches the estate tax again.
What the Surviving Spouse Can Access
The surviving spouse doesn’t lose the use of these assets, but the access comes with limits. Those limits are what keep the trust working. If the surviving spouse had unrestricted control, the IRS would pull the assets back into their taxable estate under the general power of appointment rules, defeating the entire point.6Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment
Income for Life
The surviving spouse is typically named as the primary income beneficiary and receives all of the trust’s income for the rest of their life. Interest, dividends, rental income — it all flows to the surviving spouse without restriction.
Principal Under the HEMS Standard
Principal is harder to reach. Distributions from the trust corpus are usually restricted to an “ascertainable standard” covering health, education, maintenance, and support, commonly abbreviated HEMS. The tax code specifically provides that a power limited to this standard is not a general power of appointment, so the trust assets stay out of the surviving spouse’s estate.6Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment The trustee can pay for medical bills, tuition, housing, and similar needs, but not luxury spending or gifts to third parties.
The Five-and-Five Power
Many credit trusts give the surviving spouse an annual withdrawal right known as a five-and-five power: the greater of $5,000 or 5% of trust value each year, with no justification required. The tax code treats a lapse of this power as a release only to the extent the lapsing amount exceeds that $5,000-or-5% threshold, so this withdrawal right does not trigger estate inclusion.7Office of the Law Revision Counsel. 26 USC 2514 – Powers of Appointment Unused withdrawal rights expire at year-end and don’t carry forward.
Limited Power of Appointment
The surviving spouse may also hold a limited power to redirect where the remaining trust assets go at their death, but only among a defined group, usually the couple’s children or grandchildren. The power must specifically exclude the surviving spouse, their estate, their creditors, and the creditors of their estate. If any of those four could receive trust property, the power becomes a general power and the whole trust is swept into the surviving spouse’s taxable estate.6Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment
The Basis Trade-Off That Can Cost Families Money
Here is the part most families underestimate. When someone dies, assets included in their taxable estate generally receive a stepped-up basis equal to fair market value at the date of death, which wipes out all built-in capital gains.8Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Credit trust assets get that step-up at the first death. But because those assets are deliberately kept out of the surviving spouse’s estate, they do not get a second step-up when the surviving spouse dies. That lost step-up can be expensive.
Picture a $2 million stock position moved into the credit trust at the first spouse’s death. Its basis resets to $2 million. Fifteen years later it’s worth $8 million. The children inherit it with the original $2 million basis and owe capital gains tax on $6 million of appreciation if they sell. Had the same stock been left in the surviving spouse’s estate, it would have received a fresh step-up to $8 million and the children would have owed nothing.
For estates comfortably below the combined federal exemption, this trade-off can turn a credit trust into a net loss. The estate tax savings may be zero because no tax was ever owed, while the capital gains cost is very real. Many planners now use flexible designs that let the trustee or surviving spouse decide after the first death whether to fund the credit trust at all.
Credit Trust vs. Portability
Since 2011, a surviving spouse has been able to claim the deceased spouse’s unused exclusion, known as the DSUE, through a mechanism called portability.9Internal Revenue Service. Estate Tax In theory it accomplishes the same goal as a credit trust: both spouses’ exemptions get used. In practice the two paths differ in ways that matter.
- A credit trust shelters all future growth on assets inside it. Portability transfers a fixed dollar exemption that does not grow with the assets.
- Properly structured credit trust assets are generally shielded from the surviving spouse’s creditors, lawsuits, and future liabilities. Portability transfers an exemption, not asset protection.
- A credit trust locks in who ultimately inherits. The deceased spouse’s children are guaranteed their share no matter whom the surviving spouse remarries or how the surviving spouse rewrites their own estate plan. Portability leaves everything in the survivor’s hands.
- A credit trust shelters actual assets at the exemption level in effect when the first spouse dies. Portability depends on the exemption remaining at least as generous years or decades later when the second spouse dies.
Portability has one real advantage: simplicity. It still requires filing Form 706 to elect the DSUE amount, even if no tax is owed, and the return must be filed on time including extensions. Miss the deadline and the deceased spouse’s unused exemption is gone.10Internal Revenue Service. Instructions for Form 706 But it avoids the ongoing administration, annual tax filings, and trustee duties a credit trust creates.
When State Estate Taxes Change the Decision
The federal exemption is $15 million per person, but roughly a dozen states impose their own estate or inheritance taxes with much lower thresholds. Oregon’s exemption starts at $1 million. Massachusetts sets its threshold at $2 million. Several other states fall somewhere between $1 million and $7 million.
For a couple living in one of those states, a credit trust can produce real tax savings even on an estate well below the federal threshold. A $5 million combined estate in a $1 million-exemption state faces a substantial state estate tax bill if both spouses’ state exemptions aren’t captured.
Coordination gets tricky. Some states have decoupled their exemption from the federal amount, so funding the credit trust all the way up to the federal exemption could trigger state estate tax at the first death. Planners in those states often use a formula that funds the credit trust only to the state exemption and rely on portability for the remaining federal exemption.
Who Actually Benefits
Credit trusts earn their complexity in specific situations: estates large enough that both exemptions need active protection, portfolios expected to appreciate substantially, blended families where the first spouse wants to guarantee the children’s inheritance, and couples living in states with their own estate taxes. The trust also provides creditor protection that portability can’t replicate.
For a couple with a $4 million estate in a state with no estate tax, the administrative cost and the lost basis step-up on the second death are likely to outweigh the benefits. A simple portability election preserves the same exemption with none of the ongoing machinery. The right answer turns on the size of the estate, the state of residence, the family structure, and how much the first spouse wants to control what happens after they’re gone.