April 20, 2016

The Current Estate Planning Debate

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If you don’t have the information you need to make wise choices, find someone who does” Lori Hill

Prior to 2011, in smaller estates, a common estate plan was for one spouse to leave all of his or her property to the survivor. Such a scheme generally eliminated the federal estate tax in the estate of the first spouse to die. However, the property was then part of the estate of the surviving spouse. If the surviving spouse spent the estate before death or if the combined estates were not large enough to be subject to federal estate tax for a single person at the surviving spouse’s death, then an “all to spouse” estate plan did not have significant adverse death tax consequences.

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However, in many cases, the combined estates of both spouses, especially when insurance proceeds were added, were greater than the tax-exempt amount for a single person and, therefore, an all to spouse estate plan could result in a federal estate tax on the surviving spouse’s death. In that case, it became necessary for a married couple to take advantage of ‘both spouses’ estate tax exclusion. A common method to double up on the estate tax exemption was to use a By-Pass Trust, also known as the “B”, exemption, or credit shelter trust.

Rather than giving the estate of the first spouse to die outright to the surviving spouse, the first spouse to die gave the surviving spouse only as much of the estate as was necessary to eliminate all federal estate tax and gave the remainder of the estate (the tax-exempt amount) to a By-Pass Trust.

A By-Pass Trust can have all of the following characteristics: (1) the trustee can be the surviving spouse with management control of the trust assets, subject to certain minor limitations; (2) All income of the trust can be paid to the surviving spouse; (3) principal can also be distributed to the surviving spouse as needed for his or her health, maintenance, support, and education; (4) the surviving spouse could have a special power of appointment allowing the surviving spouse to reallocate the assets among the children and further descendants or other beneficiaries to take account of changed circumstances; and (5) if the special power of appointment is not used, the trust property will pass on the death of the surviving spouse to the spouses’ descendants or other beneficiaries.

On the death of the surviving spouse, the By-Pass Trust is not subject to federal estate tax in the estate of the surviving spouse and passes free of estate tax to the spouse’s descendants or other beneficiaries.

Portability, a Game Changer

The estate planning game changed when portability became effective for married persons dying after January 1, 2011. Portability, like other provisions of the estate and gift tax laws including the $5,000,000 gift and estate exclusion (indexed for inflation), was made a permanent part of the estate tax laws in 2013. Now, if any portion of the tax exempt part of the estate of the first spouse to die is not used, then with an election made on a timely filed estate tax return in the estate of the first spouse to die, that unused portion (also referred to as “Deceased Spousal Unused Exclusion or “DSUE amount”) can be transferred and added to the surviving spouse’s exemption amount, and used by that spouse on his death.

Portability has many advantages. Simplicity is achieved for a surviving spouse who does not have to retitle assets when the first spouse dies. In addition, portability can work well with certain types of assets, such as IRAs and retirement plan assets that are not generally held in a trust. Also by electing portability, all of the assets will receive a cost basis adjustment to the fair market value on the date of the surviving spouse’s death. In contrast, a second step up in basis is not available for assets that were put into a By-Pass Trust.

However, in order for the surviving spouse to use the DSUE amount, an election must be made on a timely filed estate tax return, thus generating the cost and preparation of a return that may not otherwise be required to be filed. In addition, the amount that is subject to portability:
(1) is not indexed for inflation, as the estate tax exemption is, and therefore the amount passing to heirs free of estate tax may be less;
(2) may be lost in whole or in part if the surviving spouse remarries and that new spouse dies;
(3) does not prevent the evil step parent from disinheriting the predeceased spouse’s children; and
(4) does not apply to the generation skipping tax, therefore reducing the amount that can be put into dynasty trusts when the second spouse dies.

A Balancing Act

The choice of an all to spouse plan and a portability election requires the balancing of the simplicity and income tax advantages of the plan and the potential adverse estate tax consequences of not using a By-Pass Trust. Given that portability has now been available for more than four years and there is financial data collected from estates that have either (1) elected portability or (2) chosen the traditional A-B trust option, the estate planning debate as to what is the proper estate planning choice for a married couple in a particular family and financial situation has become increasingly more interesting.

Since no one size fits all and an individual’s estate plan should be tailored to each family’s needs, if you have not already discussed with your estate planning attorney whether portability is a good option for your estate plan, it is time to have that conversation. If you would like to learn more about portability, please contact one of your B|O|S service team professionals. We at B|O|S are ready to work with you, your attorney and tax professionals on the merits and specifics of these and other investment and financial planning options.

Filed under: Estate Planning

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