By: Verena Meiser, J.D.
When married clients express a preference for a “simple” estate plan leaving everything to the surviving spouse outright, we discuss the risks of an outright bequest to the surviving spouse as well as how they may rely on portability. Portability is the tax election made by the estate of the first spouse to die that transfers the unused federal estate tax exemption of the deceased spouse to the surviving spouse. To make the election, the Executor of said estate will have to file a federal estate tax return, even if no return would have been necessary otherwise. The reason no return would be necessary for an outright transfer to the surviving spouse is that the unlimited marital deduction permits such transfers without imposing transfer tax. There are restrictions to this rule when the spouse is not a U.S. citizen. Once the portability election is made, the survivor can apply the unused federal estate tax exemption to lifetime gifts or to the survivor’s estate in addition to the survivor’s own estate tax exemption. Note that the transferred unused federal estate tax exemption of the first to die will remain at the level of said exemption in the year the first spouse dies, while the survivor’s exemption will increase from year to year, indexed to inflation.
The desirability of an outright bequest to the surviving spouse is that the surviving spouse can continue to maintain the same control and use of the property as the couple enjoyed during their time together. The risk is that all of the assets would be exposed to the surviving spouse’s creditors. If such a risk is a concern, however, the first to die could plan to transfer a portion of the couple’s estate to a marital trust, a QTIP trust, and incorporate creditor protection provisions. In both cases, the outright transfer and the transfer to a marital trust, the couple’s entire estate will be taxed as part of the surviving spouse’s estate and receive a full step-up in income tax basis upon the second death. That step-up minimizes capital gains consequences for future beneficiaries. Another reason for choosing to include a marital trust could be that the clients wish to make use of the generation-skipping transfer tax exemption that the first to die is entitled to. There is no portability for that exemption.
Clients need to understand what will happen should the surviving spouse remarries. If the new spouse dies before the surviving spouse, then the unused federal estate tax exemption transferred from the first to die is lost. At that point, the surviving spouse may use the new spouse’s unused exemption. One planning tip for the surviving spouse to avoid the loss of the first spouse’s unused exemption is to apply it to lifetime gifts before the new spouse dies.
There are many ways to plan with portability that are best discussed with an estate planning attorney.
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