Pros and Cons of Portability

     The most recent tax legislation made the concept of "portability" a permanent fixture in estate tax planning. Portability is the ability of a surviving spouse to use the deceased spouse's unused exemption amount (DSUE) and thus protect greater amounts against estate tax on the second spouse's death. Portability has the potential to be both a blessing for clients and a curse, if not used properly.

     Generally, estate planners used the credit-shelter (non-marital portion) trust to exclude an amount equal to the first deceased spouse's unused applicable exclusion amount from the gross estate of the surviving spouse, together with any appreciation and undistributed income on that share. This insured that on the death of the first spouse an amount equal to that person’s entire applicable exemption went into one trust, while any additional assets went into the marital portion and passed to the surviving spouse free of any estate tax. Now that portability is permanent, practitioners need to consider whether using a credit-shelter trust continues to be appropriate or whether reliance on portability is preferred.

     The conventional non-marital trust is a superior vehicle for reducing estate tax than is a portability election, because it avoids estate taxes not only on the initial value of assets allocated to the non-marital share, but also the appreciation and accumulated income in the non-marital share between the deaths of the two spouses. 

Portability, however, can be a superior technique in cases where

• The couple hold most of their assets in a form that cannot be used to fund a non-marital share, such as joint tenancy with a right of survivorship or contractual rights (such as life insurance and retirement benefits); 
• The estate consists largely of retirement benefits that will make funding a non-marital share less effective as a means of avoiding estate taxes; or 
• The decedent dies without having an estate plan that includes a non-marital trust. 

       Portability has a number of other significant benefits, the largest of which is simplicity. On the death of the first spouse, the entire estate can pass outright to the surviving spouse, giving that person total control over all assets. The Personal Representative of the deceased spouse's estate can file a timely Form 706 and elect to allow the surviving spouse to be able to use the DSUE amount and no part of the exemption of the first-deceased spouse is wasted. As an added benefit, the surviving spouse receives a automatic basis adjustment ("step up") when the surviving spouse dies for assets received from the first deceased spouse which are later included in the surviving spouse's estate

     Additionally, portability preserves the entire unused exemption of the first spouse to die, even if that spouse's estate was too small to use the entire exemption. A deceased spouse's estate that is valued at zero may still leave to the surviving spouse a DSUE amount equal to the entire unused applicable exclusion amount, if a timely estate tax return is filed and an election is made.

       Portability is especially useful when the first-deceased spouse's assets are largely items of income in respect of a decedent, such as retirement benefits (e.g., an IRA) and deferred annuities. Such assets are poor choices to fund a non-marital share, because they will be reduced by income taxes when they are received.

       Finally, portability is available when the assets of the first deceased spouse pass outside of the will or revocable trust, and are therefore unavailable to fund the non-marital share. This could occur if much of the decedent's assets are held jointly with the surviving spouse with a right of survivorship, or are contractual benefits, such as life insurance. Portability is still available in such circumstances.

     The permanence of portability brings many interesting planning opportunities, but it is not without its pitfalls. Next time we will discuss the drawbacks and potential traps of using portability.

Alan Ferrara