Paul O. Dillon, Attorney at Law

Married Couples can Use Estate Tax Exemptions in Estate Planning

Estate tax avoidance and mitigation are central considerations for financial security for surviving spouses. According to a recent article from The National Law Review, “Basic Estate Tax Planning for Married Couples: Opportunities For Use Of Estate Tax Exemptions,” the first spouse may leave property of unlimited value to the surviving spouse without incurring any estate tax upon the death of the first spouse. This unlimited marital deduction shields assets from estate taxes and helps support the surviving spouse. Assets can be distributed directly to the surviving spouse or through an indirect transfer to a qualifying trust for the surviving spouse’s benefit.

Most couples use trusts for asset protection, most commonly for the preservation of assets for children from a prior marriage and asset management help for the surviving spouse. The marital deduction is a valuable estate tax avoidance tool for married couples.

However, estate tax law is not generous for non-spouse beneficiaries. Legislation passed in 2013 allowed individuals to leave assets totaling $5 million in value (indexed to inflation since 2011) to non-spouse, non-charitable beneficiaries and then doubled this amount following the Tax Cuts and Jobs Act to $10 million. However, if additional legislation is not passed before the sunset date of January 1, 2026, this amount will be cut in half.

In 2013, Congress made the portability of a spouse’s estate tax exemption permanent. This allows the surviving spouse to capture and use the first decedent spouse’s remaining estate tax exemption and the surviving spouse’s own exemption. To capture this estate tax exemption, an estate tax return must be filed in a timely manner after the death of the first spouse.

If spouses have a total estate exceeding available exemptions, they may use what is known as the “Credit Shelter Trust Planning” or “Optimal Marital Deduction Planning.” A trust is established, funded with assets of the first spouse to die, to use the spouse’s estate tax exemption. Assets in the trust are available to the surviving spouse for life but are not included in the survivor’s taxable estate upon their death. The goal benefits the surviving spouse and reduces any estate tax to maximize benefits for the children and grandchildren.

Another frequently used tool is the “disclaimer” plan, which allows the survivor to move certain assets into a trust for the survivor’s benefit rather than receiving assets directly. For married couples with estates valued at less than their available estate tax exemptions, a disclaimer plan provides the “all to spouse” plan and the option to implement a tax-advantaged trust. All assets are left to the survivor; then, based on the value of the first spouse’s estate, the surviving spouse may choose to disclaim the first spouse’s assets and divert them to a tax-advantaged trust.

It must be noted that there is no “one-size-fits-all” plan for married couples who wish to care for their surviving spouse, children, and grandchildren. It’s important to understand the basic estate tax avoidance or mitigation tools to create an estate plan to consider the couple’s planning goals and values. An experienced estate planning attorney can create a comprehensive estate plan to suit each family’s needs.

Reference: The National Law Review (June 24, 2023) “Basic Estate Tax Planning for Married Couples: Opportunities For Use Of Estate Tax Exemptions”

How Does Portability Work in a Second Marriage Estate Plan?

Despite its advantages, portability isn’t always the solution, even as it’s been used to take the pressure off couples to focus on using as much estate and gift tax exclusion as possible after the first spouse’s death. According to a recent article from Wealth Management, “Portability and Second Marriages,” portability might be a mistake.

The couple and their estate planning attorney need to consider whether leaving the executor with the discretion to use portability is appropriate, and if it is, who the executor should be and how the estate tax burden should be allocated.

The problem with portability in nonstandard families is this: it allows the surviving spouse to use the DSUE (Deceased Spouse’s Unused Exemption) amount personally, instead of requiring it be used for the beneficiaries of the first spouse to die. It’s almost like leaving assets outright to the surviving spouse. In the case of a testate decedent, Treasury regulations provide that only the executor may make the portability elections. The executor should probably not be also a beneficiary and should not be responsible for making the portability election.

Let’s say the estate isn’t large enough to require an estate tax return filing. If the executor is a child from a prior marriage, they may not choose to incur the expense of filing an estate tax return solely to make the portability election for the second spouse. Instead of having the family involved in a disagreement over the need for a return or determining who will pay for its preparation, a better option is to have the estate plan direct whether an estate tax return should be filed to elect portability and if this is done, establish who is responsible for the cost of the preparation and filing.

In complex families with children from a prior marriage, a Qualified Terminable Interest Property (QTIP) trust is used for the surviving spouse, with the trust assets eventually passing to the client’s descendants. However, if the QTIP trust is combined with portability, the estate plan may not operate as intended.

Here’s an example. Ted marries Alba several years after his first wife, Janine dies. Ted has three children from his marriage to Janine. He bequeaths most of his estate to a QTIP trust for Alba and the remainder to his children, naming Alba his executor. At Ted’s death, Alba elects QTIP treatment for the trust and portability. She then makes gifts of her assets to her family using Ted’s DSUE amount. Alba dies with an estate equal to her basic exclusion amount, which she also leaves to her family. The QTIP trust pays estate tax, and Ted’s children receive no benefit from Ted’s exclusion amount.

Even if Alba didn’t make gifts to her family, assuming her estate was large enough to absorb most of her applicable exclusion amount (including the DSUE), the QTIP trust would have to contribute to pay the estate taxes attributed to it unless the estate plan waives reimbursement. Thus, the QTIP trust could bear most or all of the estate tax at the death of the second spouse, while the second spouse’s personal assets are sheltered in part by the deceased spouse’s DSUE amount.

In cases like this, the prudent course of action may be to use traditional credit shelter/marital deduction planning. If there’s a DSUE amount available, the estate plan could direct whether it will be used and how the tax burden on the QTIP trust is handled.

An experienced estate planning attorney will look at the family’s situation holistically and evaluate which strategies are most appropriate to distribute the property per the parent’s wishes to minimize taxes and ensure that the estate plan achieves its goals.

Reference: Wealth Management (June 21, 2023) “Portability and Second Marriages”

What Do I Need to Know About Portability?

Tax efficiency means transferring the most assets, while paying the least amount of estate tax. In the past, this meant complex trust structures. However, with portability, it’s much simpler.

The Monterey Herald recently reported, in the article “Financial planning: What you need to know about portability,” that the federal lifetime estate tax exemption determines how much wealth a person can leave to their family, without being subject to estate tax. The current lifetime estate tax exemption is $11.4 million, which means that you can leave up to $11.4 million to your heirs, without the 40% estate tax on whatever remains.

With individual taxpayers, this is pretty straightforward. However, with couples, it becomes more complicated.

For example, assume a married couple has an estate worth $18 million. The husband dies first without using any of his estate tax exemption. The wife dies two months later, leaving the entire estate to their children. Without portability, it’s “use it or lose it” for the estate tax exemption.

When the husband dies, the entire estate passes to his wife (if she is a U.S. citizen) without any estate tax implications. This is known as the unlimited marital deduction rule. However, when the wife dies two months later, the estate will owe estate tax of $2.64 million, or the value of the estate above the wife’s $11.4 million exemption times the 40% estate tax rate.

That’s why trusts were so essential in pre-portability estate planning. Before portability, any unused estate tax exemption went to fund a bypass trust. The bypass trust was usually set up to provide for the health, education, maintenance, and support of the surviving spouse. The remaining assets went to the surviving spouse in a marital trust. The trust structure helped make sure the estate tax exemption of the first-to-die spouse was used to its fullest, but it also increased the paperwork with estate transfers.

With portability, the unused estate tax exemption transfers to the surviving spouse. In the example, the wife’s lifetime estate tax exemption after her husband’s death would be $22.8 million (her $11.4 million plus his unused $11.4 million.) When she dies two months later, the estate value of $18 million is below the combined lifetime exemption. Voila! No estate tax is owed.

Portability isn’t automatic. For a surviving spouse to claim the deceased spouse’s unused estate tax exemption, the decedent’s executor must file IRS form 706 within nine months of the decedent’s date of death. If you need more time, you can ask for an automatic six-month extension.

Speak with your estate planning attorney to learn how to maximize the assets that you can leave to loved ones.

Reference: Monterey Herald (February 27, 2019) “Financial planning: What you need to know about portability”