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Estate Planning and Portability

The American Taxpayer Relief Act of 2012 (ATRA), which tried to keep us from going over the "fiscal cliff," raised the federal estate tax exemption to $5.25 million and made permanent an estate tax concept called "portability." How long the exemption will stay at $5.25 million (ignoring annual inflation adjustments) is anybody's guess.

"Portable" means easily carried or transferred, like a portable typewriter (remember those?). In this case, "portable" means easily transferred to a surviving spouse.

The federal estate and gift tax gives one exemption per person, so with planning, a married couple can potentially use two exemptions. For years, the classic estate plan for a married couple with assets over the exemption amount has been to divide assets between the spouses and for each spouse to have an estate plan which creates a trust on the first spouse's death, or at least the possibility of funding a trust with a disclaimer. The first spouse to die's exemption is applied to the trust, by-passing the tax. The surviving spouse is the beneficiary of the trust during his or her period of survivorship. When the surviving spouse dies, he or she gets another exemption, and the assets in the by-pass trust are not taxed again. Thus, the couple has used two exemptions.

Critics of the estate tax point out that the practical effect of this is to create two systems of estate tax: one for those who consult lawyers and make estate plans with by-pass trusts, and a second system of taxation for those who don't.

The idea for portability of the exemption is that it is a way for both spouses' exemptions to be used without separating title to assets and creating a by-pass trust.

In order to "port" a deceased spouse's exemption to the surviving spouse, the executor of the first deceased spouse's estate must file a federal estate tax return and make an election to allocate the unused exemption to the surviving spouse. That means that for estates of decedents for which a federal estate tax return would normally not be filed, a federal estate tax return will now have to be filed just to "port" the exemption. Where there are separate families because of second marriages, there will be situations where the fiduciary who is responsible for the first dying spouse's estate will not cooperate to make the election. Some commentators have suggested that wills (or codicils) include language to permit the surviving spouse to require the filing of an estate tax return and the filing of the election, and may require the surviving spouse to pay expenses attributable thereto.

The deceased spouse's unused exemption amount is the "DSUEA." Only the last deceased spouse counts. A surviving spouse does not lose the first deceased spouse's DSUEA by remarrying (or remarrying and divorcing). Only when the subsequent spouse predeceases the survivor during marriage does he or she replace the prior spouse for purposes of determining the DSUEA available to the surviving spouse.

Even with portability, we recommend that married couples continue to structure their estate plans to take full advantage of their estate and gift tax exemptions by using by-pass trusts and splitting up ownership of their assets. There are several reasons for this:

-There is no guarantee that there will be a DSUEA in the future.
-Appreciation of assets placed in the by-pass trust will escape estate taxation in the survivor's estate.
-Creditor protection for by-pass trust beneficiaries is achieved.
-Funding of the trust helps ensure that the children of the first dying spouse have a good chance to receive an inheritance, especially if the surviving spouse remarries and is inclined to share assets with the next spouse and his or her family.
-The generation-skipping transfer (GST) tax exemption is not portable so without a by-pass trust to which the first dying spouse's GST tax exemption could be allocated, the first spouse's GST tax exemption could be lost.

The disadvantages of a by-pass trust are:

-There would be no further stepped-up basis on death of surviving spouse (although perhaps an unrelated trust protector could dissolve the trust for distribution to surviving spouse).
-The first estate may consist in large part of property that it is desirable to leave to the surviving spouse rather than to be put in a by-pass trust (for example, an IRA, which can be rolled over by the spouse but not by the trustee of a by-pass trust).
-If the estate tax is repealed (for real), then administrative costs are wasted (accounting, income tax returns, etc.).
-Some clients think it's too complicated to have a trust.

-Patti Spencer

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Spencer Law Firm LLC
320 Race Ave
Lancaster, PA 17603

Toll Free: 866-639-5451
Phone: 717-207-7935
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