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Portability—Game Changer for Estate Planning or More of the Same?

148037463Estate planners are taking a second look at portability—the use of a deceased spouse’s lifetime exclusion by the surviving spouse—now that the law on this subject has been made permanent.

Under IRC §2010(c), the deceased spouse’s executor can make an election on the estate tax return to allow the surviving spouse to use the deceased spouse’s unused exclusion (DSUE) amount on the survivor’s death or to make lifetime gifts.

Each person has a lifetime exclusion amount of $5 million plus cost-of-living adjustments ($5,250,000 in 2013) before paying estate and gift tax. Portability means the survivor can also use the deceased spouse’s lifetime exclusion amount. If the deceased spouse leaves everything to the surviving spouse, the survivor can exclude up to twice that amount ($10,500,000) from estate and gift tax.

There’s little to lose by making the election when neither spouse has a large enough estate to use the entire lifetime exclusion amount—and it will be useful if the survivor wins the lottery or has another windfall. But making the election may require filing an estate tax return on the first death when otherwise none was needed.

Some practitioners recommend a strategy of not using the deceased spouse’s exclusion amount on the first death even when there could be an estate tax on the second death. Instead, they suggest leaving all or most of the decedent’s property to a “QTIPable bypass trust” and making a QTIP election for the trust. This qualifies the decedent’s estate for the marital deduction and causes inclusion of the property in the survivor’s estate. The property is then shielded in the survivor’s estate by using the DSUE amount.

A variation on this approach uses the DSUE amount to make lifetime gifts to grantor trusts and uses the survivor’s exclusion amount to shield the bypass trust. See Franklin & Law, Portability—A Game Changer for Estate Planning?, Estate Planning 2013, chap 3 (presented at the 35th Annual UCLA-CEB Estate Planning Institute in May 2013).

The basic idea of these alternatives is to get a bigger step-up in basis on the survivor’s death by causing inclusion of additional appreciated assets in the survivor’s estate. For example, spouses with $8 million in community property would cause inclusion of the entire estate on the survivor’s death, rather than $4 million as in conventional estate planning. If the $4 million of additional trust property grows to $5 million in the meantime, the trust beneficiaries could avoid income tax on $1 million of capital gains.

But there are drawbacks to these alternative methods:

  • What if assets grow too much, so there’s now an additional estate tax that could have been avoided? (Note that the DSUE amount is not indexed for inflation)
  • What if assets go down in value, so there’s now a step-down in basis?
  • What if the surviving spouse remarries and the new spouse dies first or the survivor dies without making gifts? (The  DSUE amount does not carry over to the new spouse.)

And practical and ethical issues arise if the beneficiaries of the bypass trust aren’t the same as the survivor’s beneficiaries, such as the following:

  • What if the survivor chooses not to make anticipated disclaimers when the resulting tax savings would benefit the decedent’s children?
  • What if the executor refuses to make an expected portability election that would benefit the survivor’s children?
  • What if the survivor or the executor fails to make the QTIP election or the portability election?

Practitioners pondering portability may wish to reconsider the simple virtues of conventional estate planning. For more discussion of these portability pitfalls, check out the June 2013 issue of CEB’s Estate Planning & California Probate Reporter.

Enjoy chewing on these tricky estate planning issues? Check out other CEB blog posts on estate planning.
© The Regents of the University of California, 2013. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

6 Responses

  1. […] A certified copy of the will also may be needed as an attachment to the estate tax return. These days, even small estates may file returns because of portability. See Portability—Game Changer for Estate Planning or More of the Same? […]

  2. While reasonable minds can disagree, there may be significantly better techniques beyond those suggested above to maximize the income/ basis advantages on the second spouse’s death. There was a recent ABA program which discussed these issues in some detail. The Qtipable by pass trust also has the problem that it assumes the current Rev Proc will be disregarded by the IRS. I hope in the next year CEB will update its discussion of these fundamental estate planning issues.

    • If you want to control the ultimate disposition of the property, which I think is essential, and you want to apply the deceased spouse’s GST exemption, then there really is no alternative to a QTIP trust. (Some have suggested giving surviving spouses general powers of appointment that don’t give them actual control over disposition, but I’m much more wary of that possibility. Ultimately, a power to appoint to creditors of the estate or to pay claims and expenses either allows the survivor to commit to give the property to someone else or isn’t really a general power.) I think concerns over the application of Rev Proc 2001-38 (which we described in the June 2013 Reporter issue) may be overstated. At the recent Tax Bar annual meeting, an IRS representative questioned whether a revenue procedure could overcome a statute. Anyway, I think it’s unlikely to happen without warning. Again, unless you are willing to leave everything to the surviving spouse, you have little to lose by planning for a QTIP trust.

      • I am not sure your analysis is correct. A constrained General power of appointment using a non adverse party may work better better to control the ultimate disposition and allow GST exemption allocation. There is no objective doubt that a constrained GPA “works” for estate tax and income tax purposes. Some people are wary of assuming that a Rev Proc which is directly on point will be disregarded by the IRS . The Qtip trust solution also has the significant risk of having to pay avoidable estate tax on the second spouse’s death if the second to die spouse’s assets or the QTIP trust grows too much in value. You also have to pay out all of the net income on a QTIP which is not optimal if one is concerned about creditor’s protection. Finally, the basis allocation results with the QTIP trust solution is inferior to the general power of appointment solution in most fact patterns particularly where there are assets whose value is lower than their basis. CEB should consider doing an open minded program in 2014 on this subject in which California attorneys could consider all of the different options and their estate planning consequences

  3. […] Portability—Game Changer for Estate Planning or More of the Same? […]

  4. […] Portability—Game Changer for Estate Planning or More of the Same? […]

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