How Estate Tax Exemption Portability Provides Relief

Over the past decade the effective estate tax exemption has risen from $600,000 to $5.340 million for 2014.  Of course, there is an unlimited marital deduction that allows one to transfer as many assets as is desired to their surviving spouse at death.  That actually created a problem, which created common estate tax planning needs.  The problem was that each spouse had an exemption, but if all assets passed to the surviving spouse at death under the unlimited marital deduction, then the effective exemption of the first spouse to die would be unused and lost.

A common planning technique used by estate planning lawyers for years was to create a “family trust,” also called a “credit shelter trust.”  Assets would be split between spouses so that outright transfer to the surviving spouse would be avoided.  Then assets owned by the first spouse to die would be transferred to a trust for the benefit of the surviving spouse.  The surviving spouse would not have unfettered access to the funds in this trust, however the funds could be used for the health, education, maintenance and support of the surviving spouse.  This was just enough of a limitation to avoid triggering the use of the unlimited marital deduction.  As such, the exemption of the first to die’s estate would be used, rather than lost.  The effect was to basically double the amount of assets shielded from the estate tax.  Additionally, assets held in the credit shelter trust could grow, and even though they might eventually exceed the exemption amount before distribution after the surviving spouse’s death, they would never be subjected to estate tax at that time.

The above was historically very valid planning.  As the estate tax exemption rose from $600,000 to $1.5 million to $3.5 million and now going to $5.34 million, estate planners found it unnecessary to utilize the credit shelter trust technique as often.  If the exemption was $3.5 million and the total estate was $2.0 million, and the clients were elderly, it wouldn’t be worthwhile to separate assets and establish a credit shelter trust as the exemption of even one spouse would adequately shelter the entire estates of both spouses at the survivor’s death.

Even though the exemption rose, many estate plans have not been reviewed to see if the credit shelter technique is necessary.  Further, many practitioners were very hesitant to assume that the exemption would remain as high as it is now.  With the adoption of the American Taxpayer Relief Act of 2012 (the “Act”), we have stability on the exemption amount and it is tied to an inflation adjustment so it will not take an act of Congress to increase it.

Of even greater importance is that the Act adopted “portability” of the exemption between spouses.  Portability is probably one of the most efficient tax tools created in many years, though there is some room for improvement.  The basic concept is that portability allows the surviving spouse to use the deceased spouse’s unused exemption.  It is now no longer necessary to create a credit shelter trust because you can access the first spouse to die’s exemption by timely filing an estate tax return.  This is the only downside, you may have to file a return simply for the sake of portability.  Nevertheless, this is a simpler and cheaper tool than separating assets and administering a trust for the benefit of the survivor’s life.  Ideally, the government would create an easier way to elect portability than filing an estate tax return.  

From a planning perspective, our office is taking advantage of the opportunity to remove the credit shelter provisions from our client’s estate plans.  This allows for a consolidation of assets.  One objective we always have when preparing an estate plan is to seek to reduce the burden of administration at the death of the first spouse.  There is little reason in many cases to preserve the complex credit shelter provisions of an estate plan and the ongoing administration of that plan until the death of the surviving spouse.  A proactive plan is necessary as it is not possible to “un-do” the credit shelter provision after the first spouse dies.  If you have one of these plans, or have a client that has one of these plans, feel free to contact our office for a review to determine if it is possible to amend your documents to streamline estate administration for the surviving spouse and family.