Last time, the discussion was on the federal estate tax and how it was calculated. Recall that the 2014 estate tax exclusion amount is $5.34 million for individuals and $10.68 million for married couples. Married couples also have a tool – known as "portability", which was introduced last time, but not fully explained. As promised, this article will delve into the concept of portability, and how it works with federal estate tax.
"Portability" is the federal estate tax concept that provides that when a spouse dies, any unused estate tax exclusion amount transfers over to his 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. In other words, if a spouse dies and has not used all of his or her federal estate tax exclusion amount, the unused portion is available to the surviving spouse at her death.
A very important thing to remember includes the requirement that portability be preserved at the first spouse’s death. The surviving spouse must make an "affirmative election" within 9 months of the deceased spouse’s death to claim the use of portability. This affirmative election is accomplished by filing a federal estate tax return – IRS Form 706.
Portability is a great tool for married couples and their estate planning. However, I view it as a "safety net" in estate planning. I do not see it as a complete replacement for the need of credit shelter trusts. The following explains why:
1) Volatility in Estate Tax Legislation
a. The federal estate tax is "permanently" set for $5,000,000 and indexed for inflation. 2014 has an exemption of $5,340,000 per person. What "permanent" means is that the law will not automatically revert back – or "sunset" to earlier exemption amounts. Permanent does NOT mean our Government is precluded from changing the law in the future.
b. A credit shelter trust completely preserves the assets within it, based on the laws in place in the year of death.
2) Protect from Appreciation – "Freeze" the Value of Assets
a. With portability, when the first spouse passes, the values of the assets transferring to the survivor are not "frozen." In other words, the values of the assets are not locked in place at that time, because they transfer to the surviving spouse as an individual. As a result, the appreciation which occurs between the deceased spouse and the surviving spouse’s deaths will all be exposed for estate tax determination.
b. A credit shelter trust that is properly funded at the first spouse’s death will exclude all appreciation on the assets during the surviving spouse’s life from estate tax. This means that the assets within the credit shelter trust go to the heirs free of any estate tax, at the death of the surviving spouse.
3) Continued Protection in the Event of Remarriage
a. Portability ability is restricted in the event the surviving spouse remarries. If a surviving spouse remarries and then also survives their new spouse, the amount of unused exclusion available for use by the surviving spouse will be the unused exclusion of the last spouse to die. The first spouse’s exclusion is not protected with portability, in the event of a remarriage.
b. A credit shelter trust can serve as a protective vehicle in the event of a remarriage. It is also a good tool to help protect assets for the children, in the event of a remarriage – assuming it is drafted appropriately.
4) State Specific Estate Tax Planning?
a. Remember, portability deals with federal estate taxes. There are some states in the country which have their own state estate taxes. These states may not have portability available to preserve both exemption amounts. Minnesota, the state I live in, has its own state estate tax. Here, credit shelter trusts are commonly used to preserve both exemption amounts for married couples. Check with your attorney to see if your state has its own state estate taxes.
This article has touched on the basics of portability. It can be a good tool; but I caution sole reliance on it as an estate planning tool. Please consult your attorney to determine what works best for you.