Portability of Unused Exemption between Spouses
TRA 2010 introduced portability into the estate tax system, a concept that has been floating around for a while but has never been enacted. Portability allows a surviving spouse to use a predeceased spouse’s unused applicable exclusion amount, effectively doubling the amount that a married couple can pass to their beneficiaries free of tax.
Under TRA 2010, any applicable exclusion amount that remains unused at the death of the first spouse to die (called the “deceased spousal unused exclusion amount”) can be used by the surviving spouse in addition to the spouse’s own exemption. Portability applies only for spouses who die after December 31, 2010 (i.e., there is no portability for decedents who died in 2010).
Married couples have been employing estate planning techniques to achieve portability for years. But this took special planning. A married couple’s estate plan would usually include a “credit shelter” disposition of assets that would make full use of the applicable exclusion amount of the first spouse to die. Credit shelter trusts were often used to support the surviving spouse while sheltering the assets from inclusion in his or her estate. Although credit shelters will continue to play an important role in estate planning, portability could provide needed relief for some who fail to plan properly.
If the surviving spouse has had more than one predeceased spouse, the amount of unused exclusion is limited to (a) the lesser of $5 million or (b) the unused exclusion of the last predeceased spouse. These limitations are intended to prevent individuals with more than one predeceased spouse from aggregating more than one spousal exemption to increase the amount that he or she can transfer free of tax.
Portability can only be elected on a timely-filed estate tax return of the predeceased spouse whose exemption is intended to be used, regardless of whether the estate of the predeceased spouse is otherwise required to file a tax return. In other words, to claim the predeceased spouse’s exclusion amount for the surviving spouse, the executor of the predeceased spouse will need to file an estate tax return even if the predeceased spouse’s estate is not taxable.
Planning for Portability
The introduction of portability into the transfer tax system is a welcome development, but not a cure-all. There are still reasons to incorporate tax planning into the estate plan, not the least of which is TRA 2010’s potential sunset at the end of 2012. Trusts will also continue to play a key role in estate planning, including planning for blended families, asset protection, and greater control over trust assets. And since portability does not apply to unused GST exemption, trusts will still be needed if the GST is potentially applicable. Disclaimer trusts are also a particularly attractive option in this environment, and we have been relying on them extensively in our practice.
For some individuals, the portability election should be referenced in the estate plan. A provision directing the executor or trustee to elect portability of any unused exemption could be prudent, particularly in a second marriage or other situation where family tension is likely.
Portability is also important from an administration standpoint. Given the lingering uncertainty in the tax laws, portability should be considered for the estates of everyone who dies after 2010. Since portability can only be elected on a timely-filed estate tax return of the predeceased spouse, a failure to file the return could result in loss of the opportunity. This could be disastrous if the applicable exclusion returns to a lower amount in the future. Tax preparers and those involved in the administration of estates should consider making the election to preserve flexibility, even if the estate tax return is not otherwise required.
About Jeramie Fortenberry