Estate Tax Laws Warrant Exclusion and Portability in Planning
The new estate laws are challenging to comply with and will require most high net worth individuals to review their existing plan. One of the major issues is how the trust is divided on the death of the first spouse, and who makes certain elections. There are other critical decisions that need to be made to protect assets and minimize or delay estate taxes.
Prior Exclusion and 2013 Change
Estate tax was temporarily repealed under the Bush administration. With that exception, estate planning for married couples has been consistent since 2001. The estate tax rates have increased and exclusion from estate taxes per person ("Lifetime Exclusion")  increased from $1,000,000 in 2001 to $3,500,000 in 2009. The Lifetime Exclusion was scheduled to return to $1,000,000 per person in 2013, with the highest marginal Estate Tax rate returning to 55%. Instead the Obama Administration and Congress agreed to keep the increased Lifetime Exclusion, subject to an inflation adjustment as set forth in the following schedule.
Lifetime Exclusion Amount
Highest Marginal Tax Rate
$5,000,000 per person
$5,000,000 per person
$5,120,000 per person
$5,250,000 per person (inflation adjusted)
Planning under the 2013 changes for the Lifetime Exclusion allows the surviving spouse flexibility and minimizes taxes on the death of the first spouse. However, to take full advantage of the new estate tax laws require careful planning.
EXCLUSION PLANNING EXAMPLE 1
Under 2013 laws, husband ("H") and wife ("W") live in a community property state and have a combined community property estate of $8,000,000. H dies in 2013 and because he has no estate plan, his share of the community all passes to W. H's share of the community property is $4,000,000 and W's share of the community property is $4,000,000. Because of the unlimited marital deduction, upon H's death there is no estate tax. However, on W's death, presuming that there is no change in estate value, there is a taxable estate of $8,000,000.
Result on H's Death: No Estate Tax. All assets go outright to W. W can use them all and give then to anyone she wants, even a new spouse.
Result on W's Death: W can use her Lifetime Exclusion of $5,250,000, leaving a taxable estate of $2,750,000. Estate tax is $1,045,800.
EXCLUSION PLANNING EXAMPLE 2
H and W live in a community property state and have a combined community property estate of $8,000,000. H and W prepared a Revocable Living Trust ("RLT") prior to 2010 and all of their property has been transferred into the RLT. In 2013, H is the first spouse to die. H's $4,000,000 share of the community property estate is allocated to an "Exclusion Trust" to use up part of H's Lifetime Exclusion. W's $4,000,000 share of the community property estate is allocated to a "Survivor's Trust".
Result on H's Death: No estate tax. H did not use $1,250,000 of his Lifetime Exclusion, because of the size of H's taxable estate. All community property assets are stepped up (or stepped down) in basis to fair market value as of the date of H's death.
Exclusion Trust during W's Lifetime:
- W can be the sole beneficiary and the Trustee
- W can receive all the income and principal for her heath, support, maintenance and education
- W, on one day each year, can have the right to withdraw an amount equal to the greater of 5% of the trust estate or $5,000.
- Upon the death of W, the amount in the Exclusion Trust is not included in W's estate for estate tax purposes
- The Exclusion Trust passes as provided in the RLT after the death of W
- W can be given a limited power of attorney to change the provisions for H's and W's children, grandchildren, etc. and their spouses
- Otherwise, cannot be amended or modified by W.
Survivor's Trust during W's Lifetime:
- W is the sole beneficiary and the trustee.
- W receives all the income and principal at any time she desires
- W can change the beneficiaries, including to a new spouse
- W can modify or amend the Survivor's Trust
- If W does not make changes, Survivor's Trust passes on W's death as provided in the RLT after the death of W
Result on W's death:
Assume assets in Exclusion Trust have doubled in value and are worth $8,000,000. The $4,000,000 in appreciation is not subject to Estate Tax on W's death. Assuming that the Exclusion Trust is distributed outright to H's and W's children, when the appreciated assets are sold, they will have an income tax gain (possibly a capital gain) on the appreciation of $4,000,000. There is no Estate Tax on W's death if the fair market value of the assets in the Survivor's Trust is less than or equal to W's Lifetime Exclusion of $5,250,000.
The Advent of Portability and DSUEA
Upon the death of the first spouse ("Decedent"), an election can be made to elect to carry over to the surviving spouse ("Survivor"), the Deceased Spouse's Unused Exclusion Amount ("DSUEA"). The DSUEA was made a permanent provision in estate tax law in 2013. The concept of allowing the Survivor to use a DSUEA from the prior Decedent is commonly referred to as portability. If the Survivor remarries and the Survivor dies before the Survivor's new spouse, the Survivor still gets the benefit of the DSUEA from the Decedent plus the Survivor's Exclusion that is available on the Survivor's death.
Computation and Election of DSUEA
DSUEA is the lesser of:
- the Decedent's Lifetime Exclusion or
- the excess of Decedent's remaining Lifetime Exclusion over the sum of Decedent's taxable estate + adjusted taxable gifts made by Decedent during Decedent's lifetime.
The DSUEA election is made at the time of the Decedent's death via a timely filed Estate Tax Return (including any extensions.)  The Survivor can use the DSUEA against the Survivor's taxable estate plus the Survivor's Lifetime Exclusion.
PORTABILITY EXAMPLE 1
H made a taxable gift in 2010 of $1,000,000. H used $1,000,000 of his Lifetime Exclusion against the 2010 gift, so H did not pay any 2010 gift taxes. H died in 2013 with a taxable estate of $3,000,000. H is survived by W and all of H's estate went to his children from a prior marriage. The 2013 Lifetime Exclusion is $5,250,000. Of this amount, H's DSUEA is $1,250,000. An Estate Tax Return is filed for H, taking a DSUEA election of $1,250,000 and H has no estate tax due.
PORTABILITY EXAMPLE 2
W remarries after H's death. W also dies in 2013 with an estate of $1,000,000. W has her own Lifetime Exclusion of $5,250,000. She also has a DSUEA of $1,250,000 from H for a total of $6,500,000. She only uses $1,000,000 of her own Lifetime Exclusion. An Estate Tax Return is filed and a DSUEA election is taken for W so the DSUEA may be available for her second spouse. If W's estate had been larger, she could have used her Lifetime Exclusion plus the DSUEA from H. However, W's total DSUEA is limited to $5,250,000. If W's new surviving spouse does not remarry or dies before he remarries again, he will be able to use W's DSUEA. If W's new husband dies before W, she will lose H's DSUEA. She will only have any DSUEA of her second husband.
Planning With DSUEA
For simplicity, H and W may want to use only a Survivor's Trust for the Survivor and eliminate the Exclusion Trust.
- Ease of administration.
- Eliminates the need for one trust upon the death of Decedent.
- Eliminates need for accountings or reports to remainder beneficiaries.
- Step-up in basis of assets on death of both spouses.
- Gives Survivor total flexibility in ultimate distribution of the estate.
- Survivor has the opportunity to use entire Lifetime Exclusion of Decedent on Survivor's death.
- Helps use of Lifetime Exclusion in estates with large retirement funds.
- Planning for the personal residence and exclusion of gain may be easier, especially if the house is a large asset in the estate.
- An Estate Tax Return must be filed to capture Decedent's DSUEA.
- If there is appreciation on the assets from the Decedent' death until Survivor's death, the appreciation on Decedent's estate cannot be excluded from Survivor's estate.
- Decedent cannot control the ultimate distribution of Decedent's assets.
- A comparison of eventual tax rates needs to be made, especially with the new 3.8% tax on net investment income. 
- There are other techniques that can be used to hold the Decedent's estate in a trust for the benefit of the Survivor for life, with the remainder for Decedent's children. The provisions of this type of trust are similar to the provisions of an Exclusion Trust. DSUEA rules apply with the use of a lifetime trust for Survivor that qualifies for the "unlimited marital deduction".
- DSUEA is not indexed for inflation. By eliminating the Exclusion Trust, there may be the loss of sheltering appreciation after the death of Decedent from the estate of Survivor.
- DSUEA may not apply to state inheritance laws if Decedent has substantial assets in a state that has inheritance taxes.
- If DSUEA planning is to be utilized, additional provisions need to be added to the documents directing the appropriate elections be made and provide for the payment of the costs related to the additional provisions.
Although Congress may have intended to make estate planning easier by eliminating the need of using an Exclusion Trust to obtain the benefit of using the Lifetime Exclusion for spouses, tax and non-tax planning issues must be considered when creating and implementing an estate plan. Key considerations include:
Is it likely that your property will appreciate in value between the deaths of the spouses?
- Are the capital gains and estate tax rates likely to change?
- Will capital gains rates always be lower than estate tax rates?
- There is an election that can be made on the death of the first of you to give you maximum flexibility AND it has to be made by an independent person. Is this acceptable to either and/or both spouses? With this technique, you can protect the assets of the deceased spouse for his or her children and you can get a step-up or possibly a step-down in basis on the death of the second spouse 
- Will either you or your spouse remarry after one of you dies?
This article only addresses some of issues of the estate tax laws. It is important that you consult with a qualified tax planner to determine how to best structure your estate plan under the new estate and income tax laws that are effective in 2013.
 The "Lifetime Exclusion" has sometimes been referred to as the "Lifetime Exemption".
 President Obama's 2014 budget proposal includes a reduction of the Lifetime Exclusion to $3,500,000, with no mention of indexing for inflation.
 A discussion of the specific laws that were in effect in 2010 and the impact of an election not to be subject to the Estate Tax for a person dying in 2010 are beyond the scope of this Article.
 The Lifetime Exclusion of $5,000,000 was subject to an annual inflation adjustment starting and 2011, and remains in effect under the new Estate tax laws effective January 1, 2013.
 The Estate Tax in 2013 for a taxable estate over $1,000,000 is $345,800 plus 40% of the excess over $1,000,000. Obama's 2014 budget proposal increases this rate to 45%. It is possible through planning that a person could have used up their Lifetime Exclusion through a gifting program during their lifetime. Although the Estate Tax and the Gift Tax are two separate Tax systems, there is one combined Lifetime Exclusion for both.
 This may be different under a particular state statute if the deceased died intestate, especially if there are children from a prior marriage and children that are born to H and W together.
 This is a very common scenario. Depending on the particular circumstances, children can be the beneficiary of all or a part of the Exclusion Trust. There can also be different Trustees or Co-Trustees, including professional or corporate Trustees. A discussion of these alternatives and other planning techniques are beyond the scope of this Article.
 If this is a second marriage, the balance of H's half of the community property can be preserved for H's children from a prior marriage through the use of an Exclusion Trust and other planning.
 There is a new step-up in the income tax basis of the assets in the Survivor's Trust to the fair market value of the assets as of the date of W's death.
 The Lifetime Exclusion can be used against gifts made by a Decedent during Decedent's lifetime. If large gifts are made during lifetime, the appreciation on the gift is excluded form Decedent's estate. When the estate is calculated, the gifts (at the taxable amount when they were made) are added back to the estate to calculate the taxable estate (assets at death plus gifts made during lifetime). The result of the calculation allows the Decedent to use unused Lifetime Exclusion at death.
 An Estate Tax Return (Form 706) is due nine months after the date of death of the Decedent. A six-month extension can be made to extend the due date of 706 to 15 months after the date of Decedent's death.
 Also eliminates the necessity and expense of filing a trust income tax return on the Exclusion Trust.
 This also could include a step-down in basis if assets have gone down in value between the deaths of both spouses.
 Trusts are generally not the preferable beneficiary of retirement accounts from an income tax point of view, unless very complex rules are complied with.
 If a portion of a personal residence is used to fund an Exclusion Trust, there may be a loss of deductions for mortgage interest and property taxes; there may also be a loss of a portion of the exclusion of gain on the sale of the house.
 If the Exclusion Trust is used in a otherwise non taxable estate, an Estate Tax Return is not required to be filed.
 This is particularly important where Decedent and Survivor have children for prior marriages to protect Decedent's children's interests in Decedent's Estate.
 This article does not contain a detailed analysis of the new tax rates. The estate tax rate has a marginal 40% rate for taxable estates; the highest income tax marginal rate is 39.6%; capital gains rates are generally 20%; individual state taxes and the Medicare tax need to be taken into account in determining whether there should be planning for a total step-up in basis.
 Marital deduction trust planning is beyond the scope of this Article. The same estate tax consequences can be achieved as giving Decedent's estate outright to Survivor or in a Survivor's Trust for Survivor.
 Many states follow the federal estate tax system; however it is up to the state as to what parts of the federal law are enacted. Arizona does not have an estate tax.
 Discussion of this technique is beyond the scope of this Article.