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.

Advantages:

  • 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.

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