“Portability” is the federal estate tax concept that provides that when a spouse dies, any unused estate tax exclusion amount transfers over to his or her surviving spouse. In most circumstances, the surviving spouse is able to add the deceased spouse’s unused exclusion amount to the survivor’s own estate tax exclusion.
For example, if Jeff is married to Annie and he dies with $4 million of his $5.34 million 2014 exclusion unused, Annie’s exclusion would typically total $9.34 million — the total of Jeff’s $4 million and her own full exclusion — upon her death.
Recent tax-law changes have made this federal estate tax exclusion portability permanent. As a result, if a spouse dies and has not used all of his or her federal estate tax exclusion amount, the unused portion rolls over to the surviving spouse.
The 2012 Tax Act permanently sets the federal estate tax exclusion amount for individuals at $5 million, indexed for inflation. Thus, for 2014 the estate tax exclusion amount is $5.34 million for individuals and $10.68 million for married couples. Estates over this amount will be taxed at a top rate of 40%, up from 35% previously. The ability to port, or carry over, the unused estate tax exclusion amount of a deceased spouse to the surviving spouse is a potentially significant development, and may be reason to discuss with your attorney whether it’s a good time to review and update your existing estate planning documents.
Here is how the portability of estate tax exclusion could benefit a couple. Assume that husband and wife George and Mary each have $5.34 million estates, and neither has used any of their exclusion to shelter lifetime taxable gifts. If George leaves his entire estate to Mary at his death, it is subject to the unlimited estate tax marital deduction, and he will have used none of his estate tax exclusion. However, portability provides that George’s unused exclusion will roll over to Mary as long as Mary makes an affirmative election on George’s federal estate tax return using IRS Form 706 to claim it within nine months following his death. In this example, Mary will have George’s unused exclusion in addition to her own to distribute tax free as gifts during her lifetime or in her own estate at her death.
Historically, for married couples who wanted to fully use both spouses’ exclusion amounts, this system required careful planning to ensure the full estate tax exclusion amount could be used at the first of their deaths, regardless of the order. This form of planning typically required that a trust, often called a “unified credit trust,” “family trust,” or “credit shelter trust,” be established within each spouse’s estate planning documents so that at the first spouse’s death, it could be funded with the deceased spouse’s estate tax exclusion amount. Doing so ensured the deceased spouse’s exclusion would be used, and when the surviving spouse died, his or her exclusion amount was then available to shelter additional assets in his or her estate from estate tax.
The portability concept allows the unused estate tax exclusion amount of the first spouse to die to roll over to the surviving spouse — helping alleviate any “wasted” exclusion amount and creating greater flexibility for married couples in their estate planning. With portability of a deceased spouse’s unused estate tax exclusion amount, a husband and wife can ensure the full amount of their respective exclusion amounts are used even if their planning doesn’t do so neatly through asset titling and trust planning on the first spouse’s death.
In some situations, portability can simplify your estate planning. However, there are several compelling reasons to consider funding the deceased spouse’s exclusion amount by establishing a credit shelter trust upon the first spouse’s death. These reasons include:
What Congress has given, Congress may take away. In the past 10 years, the estate tax exclusion amount has grown substantially, rising from $675,000 per estate in 2001 to $5.34 million per estate in 2014. With the increase, many in Congress have become more vocal that the tax code has gone too far. Given rising debt levels, Congress could lower the federal estate tax exclusion amount. If that occurs, having a fully funded credit shelter trust in place from the first spouse’s death would permanently exclude the trust assets from inclusion in the survivor’s estate. Also, Congress could revisit rules around portability.
Relying on large exclusion amounts and portability raises the question of whether both will be in effect at your death or your spouse’s death.
As credit shelter trusts can be drafted in a manner to give the surviving spouse great latitude and access to trust income and principal, for larger estates — arguably, those valued at more than $5 million — there is considerable merit in continuing to use a credit shelter trust at the first spouse’s death to ensure those assets are always sheltered from estate tax, even if the exclusion amount is reduced in years following the first spouse’s death. Credit shelter trust gains are excluded from the survivor’s estate.
Since all assets in a credit shelter trust are excluded from the survivor’s estate for tax purposes, including any gain such as appreciation, on the assets from the time of the first spouse’s death until the survivor’s death. If a married couple has an estate large enough to possibly cause the survivor to incur a federal estate tax, fully funding a credit shelter trust at the first spouse’s death will also exclude all appreciation on the assets during the survivor’s life from estate tax.
Relying on estate tax portability to ensure both spouses’ estate tax exclusion amounts are used can present risks if the surviving spouse later remarries. If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion available for use by the surviving spouse is limited to the lesser of $5.34 million for 2014 or the unused exclusion of the last such deceased spouse. Such restrictions make the application of portability unpredictable in many situations. Given the possibility of future tax changes, using a traditional credit shelter trust as a means to “lock in” the use of the first spouse’s estate tax exclusion amount remains prudent in many situations.
Multi-generation trust planning that provides for the benefit during a child’s life, and then continues beyond the child’s death for the benefit of grandchildren, can provide numerous benefits for many families. When your generation-skipping transfer tax exclusion, which is equal to your estate tax exclusion amount, is applied to such a trust, your assets may continue in trust for multiple generations without being subject to estate tax at the death of each generation. Likewise, trust planning can allow you the ability to control when and how assets are used by your beneficiaries, and protect trust assets from a descendant’s creditors or a divorcing spouse. If multi-generation trust planning is appropriate in your family’s situation to address tax or other planning reasons, keep in mind that portability does not currently apply to a deceased spouse’s unused generation-skipping transfer tax exclusion.
In many instances, portability may seem appropriate for your assets. However, portability currently only applies at the federal level. If you currently live in a state with its own state-level estate tax system, the use of credit shelter trust planning within your estate planning documents may continue to make sense in order to shelter assets from estate taxes. A number of states have an estate tax exclusion far below the current federal level.
In this situation, funding a credit shelter trust with at least the state estate tax exclusion amount may be wise even where portability could suffice to shelter assets from federal estate taxes. However, the use of credit shelter trust planning during 2014 could depend on your state’s gift and estate tax rules. While credit shelter trust planning may in many instances make sense to shelter the full federal estate tax exclusion amount at the first spouse’s death, some state-specific circumstances may merit careful review with your attorney. For example, if your state has a state-level estate tax, but does not impose a state-level gift tax, it may be wise to transfer to your surviving spouse any amounts above the state-level estate tax exclusion at your death.
Married couples should explore this change in tax law and determine whether it creates opportunities to revisit your own planning. Consult your estate-planning attorney and update your existing plan to find the best strategy for your individual situation.
This article is for general informational purposes only. It is not intended to be used, and cannot be used, as a substitute for specific individualized legal or tax advice. Additionally, any tax information provided is not intended to be used and cannot be used by any taxpayer for the purpose of avoiding tax penalties. Tax and other laws are subject to change, either prospectively or retroactively. Individuals should consult with a qualified independent tax advisor, CPA and/or attorney for specific advice based on the individual’s personal circumstances. Examples included in this article, if any, are hypothetical and for illustrative purposes only.
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