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.
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