Many of you have heard of the new Federal estate tax “portability” rule that allows a surviving spouse to effectively inherit any unused federal estate tax exemption of a predeceased spouse. An individual can only use the unused estate tax exemption from his or her “last deceased spouse.” Some married clients conclude that portability means they can simplify their estate plans by eliminating the “by-pass trust” fund now found in most married couple plans. As Coach Lee Corso would say, “not so fast my friend”.
Portability will be a beneficial “second best” choice for estates of decedents who did no estate tax planning. But bypass trust planning (which is already part of most married couple plans) will continue to be the best alternative for most married couples with potentially taxable estates. Here are some of the disadvantages of relying on portability in lieu of the by-pass trust:
(i) Portability works only if the executor of the first deceased spouse files an estate tax return electing to pass the unused exemption to the surviving spouse, and executors of relatively modest estates may see the cost of filing a complete estate tax return as too high of a price to pay to get only the potential benefit of portability;
(ii) Leaving property to one’s spouse in a bypass trust affords a number of non-tax benefits which are not available if no trust is used, such as: protection from the creditors of the surviving spouse; assets can’t become commingled, and thereby subject to loss in a divorce if the surviving spouse remarries and then divorces; and the assets are assured to pass to the persons designated as beneficiaries by the deceased spouse;
(iii) Assets passing to the bypass trust are exempt from estate tax at the surviving spouse’s death, including appreciation during the surviving spouse’s lifetime (which benefit could be offset to some extent by the loss of a stepped up basis at the second death;
(iv) Portability does not apply to the deceased spouse’s GST tax exemption. By proper allocation of the GST exemption to the bypass trust, a married couple can effectively double the amount of property that will avoid estate taxation upon the deaths of their children (and their descendants); and
(v) The surviving spouse is entitled to only use the unused estate tax exemption of the most recently deceased spouse (e.g., may be no exemption to inherit if remarries a new wealthier spouse).