Written by attorney Mark Steven Drobny

Portability: A New Estate Planning Tool

The Tax Relief Act of 2010 significantly increases the "Exemption Equivalent," or the amount of property which can pass free of estate and gift taxes during an individual’s lifetime for persons dying in 2011 and 2012. In 2011, the Exemption Equivalent was raised to $5,000,000.00 per person. For persons dying in 2012, the Exemption Equivalent is $5,120,000.00.

One of the most important changes implemented under the 2010 Tax Relief Act was the addition of the portability. The concept of portability allows the decedent’s spouse to retain the decease spouse’s unused basic exclusion amount (DSUEA).

A federal estate tax return (IRS Form 706) is not required for any taxable estate that is less than the Exemption Equivalent in the year of the decedent’s death. For decedents dying in 2011, the Exemption Equivalent was $5.0 million per person, so any taxable estate below this amount was not required to file an estate tax return. However, even if a deceased spouse’s taxable estate does not require a federal estate tax return, a surviving spouse can elect portability to retain the deceased spouse’s unused Exemption Equivalent.

Under current law, we return to the $1 million Exemption Equivalent for persons dying after December 31, 2012. This is a result of a "Sunset Clause" in the new tax laws that repealsalltax cuts recently enacted, including but not limited to estate taxes, income taxes, the marriage penalty and education incentives.

Because the Exemption Equivalent is scheduled to return to $1 million per person for decedents dying after 2012, we have the opportunity to plan for you as the surviving spouse and portability should be strongly considered by all surviving spouses.

Let’s consider the following example.

Husband died in 2011, and Wife is the surviving spouse. Husband and Wife have a total estate of $3.0 million, all community property. When Husband died, his half of the estate (one-half of the community property) was valued at $1.5 million. The Exemption Equivalent in 2011 exempted $5 million from estate taxes. Because his estate was below the Exemption Equivalent, his estate passed free of estate taxes and did not require the filing of a federal estate tax return.

However, Husband did not utilize $3.5 million of his Exemption Equivalent ($5 million minus $1.5 million taxable estate). Using portability, Wife can now retain Husband’s unused Exemption Equivalent (here $3.5 million) in addition to her Exemption Equivalent upon her death.

If Wife elects portability, upon the death of Wife, her Exemption Equivalent will beadded to the deceased spouse’s Exemption Equivalent. For example, if Wife elects portability and then dies in 2013, her Exemption Equivalent will be $4.5 million (Wife’s $1 million Exemption Equivalent plus $3.5 million deceased spouse’s unused Exemption Equivalent).

On the other hand, had Wife notelected portability and died in 2013, her Exemption Equivalent will only be $1 million. As her taxable estate would be $1.5 million (assuming Husband and Wife had a Living Trust), her heirs would pay 55% in federal estate taxes on any amount over her $1 million Exemption Equivalent, or $275,000.00 ($500,000 multiplied by 55%). However, if Wife elected portability upon her death, her heirs would pay 55% in federal estate taxes on any amount over her $4.5 million Exemption Equivalent or $0.00. The potential tax savings is significant.

For decedents dying in 2011 and 2012, the executor of a decedent’s estate mustelectto allow the surviving spouse to use the remaining balance of his or her deceased spouse’s Exemption Equivalent. The Exemption Equivalent isnotautomatically transferred to the surviving spouse. In order to elect portability, the law requires that a timely estate tax return (IRS Form 706) be filed. A timely filed estate tax return must be filed within nine (9) months from the date of death or if an extension is filed, within fifteen (15) months from the date of death.

If your spouse has passed away in 2011 or 2012 and did not use his or her entire Exemption Equivalent, we strongly recommend that you take advantage of this opportunity. Please contact Michelle Glenn to schedule an appointment to meet with one of our Associate Attorneys to discuss your particular situation.

Portability vs. an A/B Trust

Even though portability is an estate planning option, most everyone should still proceed with a basic estate plan using the A/B Trust for several reasons.

First, portability is a temporary law. The Tax Relief Act of 2010 introduced the concept of portability, but portability is only available for decedent’s dying in 2011 and 2012. Because of the uncertainty of the estate tax laws, we do not recommend that you rely solely on this new law to avoid federal estate taxes.

Secondly, portability provides not asset protection. One of the main advantages of an A/B Trust is asset protection. Upon the death of the first spouse, the Living Trust is split between the A and the B Trust. One Trust is called the bypass trust and this irrevocable trust retains the assets of the decedent, while still allowing the surviving spouse the ability to access these assets, generally. As this is an irrevocable trust, if the surviving spouse were to later be subject to creditor claims, the creditor cannot attach to the assets in the irrevocable trust. If one solely relies on portability, all assets would be held by the surviving spouse and all assets would be subject to creditors.

Finally, another advantage of the A/B Trust is the protection of the appreciation of the assets, which portability cannot accomplish. For example, if a decedent dies in 2012 and passes $2.0 million to the bypass trust, and this trust appreciates in value to $3.0 million upon the surviving spouse’s death, these assets will not be included in the surviving spouse’s taxable estate. However, without an A/B Trust, upon the death of the surviving spouse, in this example, the surviving spouse’s taxable estate would include the decedent’s assets and all appreciation, which could easily increase her taxable estate over her Exemption Equivalent.

These are just a few of the many reasons that couples should continue to prepare basic estate plans in addition to using portability as another estate planning tool, especially if your surviving spouse passed away in 2011 or 2012.

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