The New Portability and Disclaimer Trusts

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This portability provision makes it possible for a married couple to transfer up to $10 million free of federal estate tax without having to use a Family Trust (see below). However,The New Portability and Disclaimer Trusts Articles without further Congressional action, on January 1, 2013, the estate and gift tax exemption decreases to $1 million per person, the top tax rate increases to 55%, and portability is repealed.

Portability is available to a surviving spouse only if an election is made on a timely-filed estate tax return (Form 706) by the predeceased spouse’s estate – even if the estate is not otherwise required to file a Form 706. However, only the last spouse’s exemption is portable. So one cannot re-marry in a serial manner to accumulate estate tax exemptions.

Family Trusts:

When a married person dies, he or she can pass all of his/her property to a surviving spouse without incurring any estate tax because of the unlimited marital deduction. So, if husband and wife each have an estate of $5 million, husband can pass his $5 million to wife estate tax free. So when wife dies, her estate would be worth $10 million. Without portability, wife could pass up to $5 million estate tax free, but her estate would be required to pay a 35% estate tax on the excess.

Prior to the existence of portability, the most common way to use both estate tax exemptions of a married couple was to create a “Family Trust” upon the death of the first spouse. Other names used for a Family Trust are “Credit Shelter Trust”, “Bypass Trust” and “Residuary Trust”. Upon the first spouse’s death, an amount equal to the decedent’s estate tax exemption is allocated to the Family Trust. The surviving spouse has access to the property in the Trust, but upon the surviving spouse’s death, the property remaining in the Trust is not included in his/her estate.

The provisions that the surviving spouse can enjoy from a Family Trust during his/her lifetime are:

  • The spouse can receive all of the income of the Trust. The trustee can also be given the power to “sprinkle” the income of the Trust to children and grandchildren (so as to shift that income to lower tax brackets, unless the so-called “kiddie-tax” rules apply), or accumulate the income and add it to principal.
  • The spouse can receive principal distributions from the Trust (see below).
  • The spouse can have the power to withdraw the greater of $5,000 or 5% of the principal of the Trust each year.
  • The spouse can be given a testamentary limited power of appointment (LPA) over the assets in the Trust. An LPA allows the spouse to “rewrite” the dispositive provisions of the Trust. However, the LPA is usually drafted so that it can only be exercised in favor of the grantor’s descendants and/or charities. The LPA cannot be exercised in favor of the spouse, his/her creditors, his/her estate, or the ¨ creditors of his/her estate.
  • The spouse can be the sole trustee of the Family Trust, provided that distributions to the spouse are limited to an “ascertainable standard” (i.e., health, education, maintenance and support).
  • Distributions to the spouse in excess of the ascertainable standard can be made from the Trust if an independent co-trustee is named to serve with the spouse, but discretion on such distributions must rest solely with the independent co-trustee.
  • The spouse can be given the power to remove the co-trustee and appoint an individual or corporate successor co-trustee that is not related or subordinate to the spouse.

Problems with Portability:

Despite the relative simplicity of just letting the surviving spouse use the predeceased spouse’s unused estate tax exemption in 2011 and 2012, there are several reasons for still using Family Trusts, including the following:

  • The predeceased spouse’s unused exemption is not indexed for inflation.
  • The first predeceased spouse’s unused exemption could be lost if the surviving spouse remarries and survives his/her next spouse.
  • There is no transfer to the surviving spouse of the predeceased spouse’s unused generation-skipping transfer tax exemption.
  • Assets that are left to a surviving spouse in trust (rather than outright) are protected from creditors.
  • The predeceased spouse cannot control who receives the remaining assets upon the surviving spouse’s death.
  • If the surviving spouse remarries and commingles his/her assets with those of the new spouse, it may result in the intentional or unintentional disinheritance of the children.
  • The future appreciation in the predeceased spouse’s assets could be subject to estate taxes at the surviving spouse’s death.
  • The portability provision is scheduled to sunset on December 31, 2012.
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