The American Taxpayer Relief Act of 2012 made many significant changes to the tax code, but one of the less-reported changes involved estate taxes, and the portability of the estate tax exemption between spouses. Estate planners have been dealing with this law for a year now, and many of them have found that there are more wrinkles to the change than initially thought. As 2014 dawns, many of your clients may want to take a second look at the benefits of the new portability and see if they may be able to take advantage of them.

The legal changes, on first blush, appear to be pretty simple: If the first spouse to die hasn’t used up all of his or her exemption from estate and gift tax, then the surviving spouse can then make use of the remaining exemption. In other words, a married couple should be able to use the full value of both their exemptions even if the first spouse to die doesn’t use a full exemption.

The ramifications of this go far beyond simple estate tax eligibility. Perhaps the primary concern is that it now sets up a real alternative to credit shelter trust for clients who have found that the best option in the past. In the past, spouses who expected to exceed the lifetime exemption have had the option of setting up an estate plan that would pass, after the death of the first spouse, assets equal to the exclusion amount into a credit shelter trust for the surviving spouse. Now there’s a simpler alternative.

However, it’s important to note that portability is not automatic. In order to trigger portability, the executor of the deceased spouse’s estate must make the appropriate election by filing a complete Form 706 with the IRS. Be careful here: Even estates that wouldn’t otherwise need to file Form 706 must do so in order to take advantage of the portability.

In fact, executors of estate that fall short of the combined exemption threshold might still want to file Form 706. The full exemption can pass from one spouse to the other even if the first spouse to die doesn’t have the full $5.34 million in his or her estate.

Consider a decedent with $4 million in his estate. He can leave the entire $4 million to his surviving wife, but he also gets to pass the full $5.34 million exemption along. If his widow’s estate exceeds $10.68 million (or whatever the limit is when she finally passes on) she can take advantage of the full value of her late husband’s exemption, not just the value of the $4 million he left to her. So anyone who might   need the entire spousal exemption in the future should consider filing Form 706.

This represents a key strategic change from the credit shelter trusts. If a husband had died with $4 million of assets that were then put into a credit shelter trust, the other $1.34 million worth of exemptions that his estate would have been eligible for would be wasted. On the other hand, there are still benefits to a credit shelter trust that don’t apply to assets transferred due to portability. Assets put into a credit shelter trust appreciate outside of the surviving spouse’s taxable estate, while the exemption amount is a hard limit. It also provides some asset protection that doesn’t apply with the portability of the exclusion. Any exemption for a generation-skipping trust can also be applied to a credit shelter trust, while that doesn’t apply to the estate exemption.

Remarriage can also throw a monkey wrench into the use of a portability exemption. If a surviving spouse intending to use her late husband’s exemption remarries, but the second husband dies before she makes use of the exemption, the second spouse officially becomes the last deceased spouse. Whatever exemptions the first husband passed along are thus lost. Remarriage doesn’t have any effect on assets that have been passed through a credit shelter trust.

These plans can be very complex, of course, and shouldn’t be undertaken without a great deal of research and consideration. But the most important idea is that portability can afford your clients another tactic in developing an estate plan, one that may even be beneficial to those who aren’t yet approaching the estate tax exclusion limit. 

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