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What is Estate Tax Portability?

Before 2010, married couples could pass on up to two times the federal estate tax exemption by including “A-B Trusts” or “A-B-C Trusts” in their estate plan. Because TRA 2010 was a temporary law, many wondered if portability was a concept that would only work for those dying in 2011 and 2012.  We can stop wondering.  The “American Taxpayer Relief Act of 2012” (ATRA) is now “permanent” law.  Under ATRA, portability is a constant principal going forward.

Now married couples may use “portability” to add any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse’s estate tax exemption. This will effectively allow married couples to pass up to $10 million (plus an inflation adjusted amount: $500,000 per couple in 2013) to their heirs free from federal estate taxes with absolutely no planning at all. With that said, it may not be wise for portability to be solely relied upon for estate tax and marital deduction planning.  Some of the limitations of portability are as follows:

Remarriage Complicates Things (for taxes too).  Be aware that the order of deaths can cause loss of a portable exemption from a prior spouse.  The portability exemption might create an incentive to later “shack up” while preserving the first deceased spouse’s exemption through portability and using a credit shelter trust for the new roommate.  An alternative to “living in sin” might be to use first spouse’s portability exemption by gift, then get married.

Necessity to File Estate Tax Return. As alluded to above, claiming portability requires the filing of an estate tax return by the executor of the estate of the first spouse to die.  Depending upon the size of one’s estate, the question of when to file the estate tax return may be complex, especially since long-term laws setting out exemption amounts remain a mystery.

GST Exemption is not Portable.  You should also understand that the $5 million GST exemption is not portable, unlike the estate tax exemption. Traditional trust planning with a bypass trust is often still necessary to avoid wasting the GST exemption.

Portability not Applicable to State Death Taxes.  Although this change may come, many state death tax regimes do not yet incorporate portability into their systems. See the attached Appendix for limited state death tax information.

Portability is Not Indexed for Inflation.  Because there is no index for inflation attached to the portability exemption, growth in the estate is better shielded from tax in a credit shelter trust.

Open Statute of Limitations.  If portability is elected, the statute of limitations on the deceased spouse’s estate remains open until the statute has run on the survivor’s estate.  Otherwise, the statute of limitations expires three years after filing of the first spouse’s estate tax return.

Asset Protection.  Use of a credit shelter trust may provide certain asset protection benefits not otherwise available to the surviving spouse.

Protecting Children from Prior Marriage.  The credit shelter trust might also help protect inheritance for children of the first spouse to die.

If you have questions about whether you and your spouse should rely upon the ATRA portability laws, or whether you should use some type of a trust to fully utilize both spouse’s transfer tax exemptions, please contact our office to discuss Estate Tax Portability further.