Before the American Taxpayer Relief Act of 2012 (ATRA) was signed into law, most estate planning for married couples involved use of “Credit Shelter Trust” language in either wills or revocable trusts. This was intended to take maximum advantage of the federal estate tax exemption on the death of the first spouse, so as to minimize estate taxes overall. All well and good, when the federal estate exemption amount was $1 million (2001), or $2 million (2002-2008) or even $3.5 million (2009). For many people in the Washington area, a home, personal assets and a defined contribution retirement plan would reach the exemption amount. When the first spouse died, the irrevocable credit shelter trust was created, and marital assets up to the exemption amount were transferred to it, managed for benefit of the survivor.
ATRA raised the exemption amount to $5 million indexed for inflation, currently $5.34 million, and introduced the concept of “portability”. Under portability, a married couple can potentially shelter $10 million, indexed for inflation, because the survivor can use any of the exemption that the deceased spouse did not use. Deborah Jacobs of Forbes Magazine called it “Estate Planning for the 99%”.
So is one better than the other? As with many legal issues, the answer is “it depends”. The executor of an estate is the one to elect portability, and as was pointed out last month, if the executor is a child of the first marriage, there may be a reluctance to benefit a step parent. Electing portability means filing an estate tax return even if no estate tax is due, and it is fairly expensive to have it prepared.
Estate planning attorneys and financial planners have recently turned their attention to the impact of income tax and capital gains tax on estates, as opposed to just estate taxes. If an executor elects portability at the death of the first spouse, it is potentially possible to have all the assets included in the estate of the second to die, and if the estate is under the exemption amount, all assets pass to heirs with the second-to-die’s date of death value. That means no capital gain if assets are sold soon after. If a credit shelter trust was established when the first spouse died, and many years passed before the survivor died, there might be substantial increase in value of the credit shelter trust assets, resulting in capital gain tax.
Then again, assets in a credit shelter trust are protected from the survivor’s creditors. The upshot is individual circumstances are key to determining whether portability offers sufficient options to minimize taxes, or whether more sophisticated planning is advisable.