As part of the American Taxpayer Relief Act of 2012, Congress made permanent the portability of estate tax exemption between spouses.  Although this change was supposed to be a simplification for married couples, after a year of experience with it, we have concluded that it is anything but simple!

Under portability, if the first spouse to die does not use up all of his or her exemption from estate and gift tax, the executor of the first spouse's estate may elect to give the use of the remaining exemption to the surviving spouse.  The surviving spouse can then use that exemption amount (the deceased spousal unused exemption amount, or DSUE) to make lifetime gifts or to shelter bequests at death.  This provides an alternative to the traditional estate planning for wealthy married couples in which a credit shelter trust, or bypass trust, is set up when the first spouse dies in order to use up the deceased spouse's exemption.  Now, with the top marginal estate tax rate set at 40% and the top income tax rate set at 39.6% (plus the 3.8% surtax in many cases), both estate tax and income considerations must be taken into account in planning.  Drafting a flexible estate plan that allows circumstances at death to be considered before making the choice between portability and a credit shelter trust often will be the best option.

Set forth below are some of the most significant pros and cons of these alternative planning techniques as they would apply to a hypothetical couple, Ozzie and Harriet.  We'll assume for purposes of this discussion that Ozzie will be the first spouse to die.

Click here to view table.

Which plan is better in any particular case turns on an analysis of many factors including:

  • The overall value of the estate
  • Anticipated increase in value of the assets
  • Anticipated estate, income tax, and capital gains tax rates applicable to the estate, the spouse and the ultimate beneficiaries of the estate
  • The rate of inflation
  • The types of assets that are owned
  • Age of the clients and the likely period of time between the two deaths
  • Applicable state law
  • Whether a surviving spouse is likely to remarry
  • Whether the couple has children from prior marriages
  • Whether it is important to be able to use the GST exemption