The “Portable” Federal Estate Tax Exemption

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The tax legislation enacted at the end of 2010, just before we were scheduled to return to a top federal estate and gift tax rate of 55% and an exemption of only $1 million, provided three significant changes in the federal estate and gift tax laws: (1) a $5 million exemption for estate, gift and generation-skipping transfer tax (“GST”) purposes, (2) a federal rate of 35% on the excess above $5 million, and (3) portability of the estate tax exemption between spouses. Unless legislation is passed to extend these provisions, we will face a $1 million exemption and a 55% tax rate in 2013 and beyond.

The Effect of Portability. Portability allows the executor of the first spouse to die to “port” any unused estate tax exemption to the surviving spouse.


  • All assets may pass through the estate of the surviving spouse, obtain a step-up in basis for income tax purposes (except IRA and other pre-tax assets) and still avoid estate tax with respect to the first $10 million.
  • For a married couple with all assets in joint names with rights of survivorship, the assets could have special creditor protection during the spouses’ joint lives (with title as “tenants by the entirety”) and would pass outside of probate at the first death.

A first reaction to these advantages might be not to plan because of the likelihood that the combined estates will be within the $10 million exemption, or to simplify the estate plan by revising documents that include traditional credit shelter trust planning. Nevertheless, there are still advantages to creating a credit shelter trust at the first death, including the following:

  • By setting aside the exempt amount at the first death, all earnings and appreciation accumulated in the trust between the first and second deaths will pass free of federal estate tax, outside of the survivor’s estate.
  • The credit shelter trust assets could be protected for children or others (regardless of a second marriage, a creditor claim against the surviving spouse, etc.).
  • The GST exemption is not portable; if the wish is to provide for transfers to grandchildren, or lifetime trusts for children with the remainder passing to grandchildren, then a credit shelter/GST trust would need to be established at the first death to ensure that both spouses could utilize their GST exemptions.
  • Uncertain whether portability will remain in the law after 2012. Even if portability is available at the first death, the law could change to eliminate portability before the second spouse’s death.
  • A surviving spouse is allowed to utilize the unused estate tax exemption of his or her last deceased spouse. Thus, if a surviving spouse remarries and again is widowed, the first spouse’s unused exemption would not be available at death; only unused exemption from the estate of the second spouse could be added to the surviving spouse’s own exemption.

Possible “Wait and See” Approach. This approach allows the surviving spouse and his/her advisors to decide whether or not to utilize the first spouse’s exemption at the time of the first spouse’s death. This can be done with “disclaimer” planning. The Will could provide for the entire estate to pass outright to a surviving spouse, with the proviso that if the surviving spouse disclaimed any portion, that portion would pass into a trust for the benefit of the surviving spouse (and children or others if desired).This would enable the surviving spouse to direct up to the exempt amount ($5 million) into a credit shelter trust. If it appeared that portability was at risk, the disclaimer would be exercised; if portability seemed permanent, then the spouse could inherit the entire estate so that all assets would obtain a step up in basis on his/her later death.

We suggest you contact your estate planning lawyer to explore these opportunities in your personal situation.

Chevy Chase Trust does not render legal, tax, or accounting advice. Accordingly, you and your attorneys and accountants are ultimately responsible for determining the legal, tax, and accounting consequences of any suggestions offered herein. Furthermore, all decisions regarding financial, tax, and estate planning will ultimately rest with you and your legal, tax, and accounting advisors.


This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. Read more: The “Portable Federal Estate Tax Exemption | Washington Business Journal

Planning Idea With New $5 Million Gift Tax Exemption

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The tax bill enacted at the end of 2010 provides a $5 million exemption from federal gift tax for aggregate lifetime gifts ($10 million for a married couple). This exemption applies for 2011 and 2012, and is in addition to the $13,000 annual exclusion gifts that may be made free of federal gift tax every year.

This increase in exemption from the prior $1 million limit for lifetime gifts allows wealthy taxpayers to consider strategies such as the creation of a Qualified Personal Residence Trust (QPRT) for a valuable first or second home.

Briefly, a QPRT works as follows:

  • A residence is transferred to a trust that provides the transferor with exclusive use of the residence for a term of years; at the end of the term, the residence is transferred to or for the benefit of others (usually children). The transferor would then pay rent to the children if he or she continues living in the residence.
  •  The gift is equal to the excess of the value of the residence over the value of what the transferor has retained (i.e., the right to use the residence for a number of years). The value of the transferor’s retained interest is determined based upon annuity factors published each month by the IRS and is dependent upon the transferor’s age, the trust term and current interest rates.
  • If the transferor dies during the trust term, then the entire value of the residence is included in his/her estate Thus, while a longer term reduces the value of the gift, it increases the chances that the QPRT strategy will not work. This is one of the factors that made the QPRT strategy less attractive to older taxpayers when the gift tax exemption was only $1 million – a shorter life expectancy made it more difficult to set the term long enough to keep the gift value below the exemption limit.

To illustrate, an 80-year-old who this month transfers a $2 million home to a QPRT with a three-year term would be making a taxable gift of $1,483,160. At the end of the three-year term, the residence would belong to the children. If the residence had increased in value 3 percent annually, the children would receive an asset worth $2,185,454 in exchange for the parent’s use of only $1,483,160 of exemption. Assuming the transferor’s total estate at his or her later death exceeds the estate tax exemption, the additional $702,294 of value that was transferred would save $245,803 in federal estate tax at a 35 percent rate (or $316,032 if the rate reverts to 45 percent; $386,262 if the 55 percent rate that is now on the books for 2013 and later years applies).

Note, however, the children’s basis in the residence will be the same as the parent’s basis at the time of gift. There will not be a step-up in basis as there would be if the property had been included in the parent’s estate. For this reason, a QPRT is often most attractive for property that will stay in the family after the parent’s death.

Many specific rules apply to QPRTs. You should consult your legal and tax advisors to determine if a QPRT is appropriate in your personal situation.


This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. Read more: Planning idea with new $5 million gift tax exemption | Washington Business Journal

Federal Estate Tax: Mixed Benefits

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Most have probably heard about the significant increase in the federal estate tax exemption and decrease in the federal estate tax rate enacted at the end of 2010. Over the past decade, the aggregate amount that may pass to people other than a spouse or charity free of federal estate tax has increased from $675,000 to where it is today at $5 million (double these amounts for a married couple). The tax rate that applies to the excess has decreased from 55 percent to the current rate of 35 percent. (Transfers to U.S. citizen spouses and qualified charity remain fully exempt.)

We highlight two potential issues that may offset some of the benefit of the new federal law.

First, for those with wills providing for the exempt amount to pass to children or other beneficiaries with the balance passing to the surviving husband or wife, the new law could have the unintended consequence of keeping a great deal more out of the spouse’s hands than expected. No federal estate tax would be due, but now the first $5 million of the estate (rather than the much lower amount that might have been exempt at the time the will was drafted) would not be available to the surviving spouse.

Second, for those living in states that have “de-coupled” from the federal estate tax law, including D.C. and Maryland, an estate that takes full advantage of the federal exemption could owe a state tax when none was expected. D.C. and Maryland, for example, have only a $1 million exemption from their local estate tax, with rates ranging from approximately 6 percent to 16 percent on any excess that passes other than to a spouse or charity. If $5 million passes into a “bypass trust” for the benefit of the surviving spouse and children, no federal estate tax would be due, but nearly $400,000 could be owed to D.C. or Maryland. (At this time, Virginia has no separate estate tax.)

Your estate planning lawyer can advise you regarding your own exposure to these issues and revisions to your estate plan that may achieve your desired results. Of course, you may have to visit your lawyer again in two years, as the current federal estate tax law is in effect only for 2011 and 2012.


This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. Read more: Federal estate tax: Mixed benefits | Washington Business Journal