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December 23

Asset Protection | Is Portability an Estate Tax Trap?

Written by Thomas Upchurch ,

Before you jump for joy at the newly adopted “portability” concept created in the American Tax Relief Act of 2012, think again.  Think asset protection along with estate tax avoidance for not only the surviving spouse, but for children and future generations.

Previously, estate planning instruments such as the Credit Shelter Trusts or Bypass Trusts, Family Trusts, Dynasty Trusts or Qualified Terminable Interest Property (QTIP) Trusts were utilized to avoid or minimize the estate tax and provide for future generations.  Portability does not appear to solve the problem as much as it emphasizes the necessity of estate planning instruments even more to ensure asset protection.

Revenue Procedure 2001-38

Revenue Procedure 2001-38 was designed to make the QTIP provision null and void under circumstances that the election was not necessary. See 26 U.S.C. §2056(b)(7). The American Bar Association stated in the ABA-RPTE Portability Regulation Comments to reevaluate:

Rev. Proc. 2011-38 in light of portability, “where one may now want to intentionally make a QTIP election in estates having less value than the deceased spouse’s available applicable exclusion amount.”  In other words, the election would not be “unnecessary.”

At the time of the issuance, there was no justification for a QTIP election for such estates. With portability, now a reason exists.

If the estate planning instruments are still needed, then what is the point of portability?

Portability’s major benefit is to allow the surviving spouse to use his or her deceased spouse’s unused exemption (DSUE).  Portability may work as a tax delay, not a tax avoidance that estate planning instruments may provide to clients. Remember, estate planning is for asset protection and long term planning, not a band-aid.

Is portability really a benefit or is it an estate tax trap for children and grandchildren for some estates?

Yes, it may be under some situations as set forth in the following portability drawbacks:

  • Deceased Spouse Unused Exemption is locked in at the time of death. If the portability election is used, the DSUE is locked in at the time of death losing any future cost of living adjustments.  This would mean that if a $4,000,000 DSUE is used, any other exemption amount above this amount is lost. The current maximum DSUE amount is at $5,250,000 and will increase to $5,340,000 in 2014 for adjustment of cost of living.

Example: In this scenario, the total exemption amount for the surviving spouse would only total $9,250,000 instead of the $10,500,000 an estate planning instrument may provide. The portability may prevent the estate $1,250,000 x 40% estate tax = $500,000 benefit.

  • DSUE locks in the property value of first to die. Any appreciation after date of death is taxed. For instance, if the first to die spouse’s property is worth $4,000,000 and it grows to $7,000,000 at the time of death of the surviving spouse, then the $3,000,000 appreciation is taxed.

Example:  Based upon the $3,000,000 appreciation x 40% estate tax = $1,200,000 estate tax bill against the surviving spouse’s estate.  This may have been avoided with an estate planning instrument.

  • First to die spouse leaves $2,000,000 to children.The portability election imposes another problem if the first to die spouse leaves any money to the children instead of all to the spouse.  The DSUE would be adjusted.

Example:  First to die spouse DSUE of $4,000,000 minus $2,000,000 to the children would leave only $2,000,000 DSUE for the surviving spouse. Once again, it may cause an estate tax burden that may have been avoided with an estate planning instrument.

  • Generation Skipping Transfer Benefit Lost. Generation Skipping Transfer (GST) benefit is lost if the portability election is made at the time of death of the first to die. The GST is not portable. The current gift tax is at 40%. This would cause a costly estate tax burden for the grandchildren and future generations that the Dynasty Trust provides.
  • Remarriage of surviving spouse may have severe estate tax consequences.  If the surviving spouse is younger and remarries, then it may impose a substantial estate tax burden if the second spouse’s estate is smaller than the first spouse. First to die Spouse DSUE was $4,000,000.  Spouse 2 DSUE is only $2,000,000. The surviving spouse could only use the remaining $2,000,000. The portability rule is that DSUE is utilized by the last deceased spouse.

Example:  Surviving spouse outlives both husband 1 and husband 2. First spouse to die provided DSUE of $4,000,000.  Second spouse provided $2,000,000. The surviving spouse loses the first to die spouses allowance preventing a $2,000,000 x 40% estate tax = $800,000 estate tax savings that may have been avoided if one of the estate planning instruments was prepared.

On the other hand, if the surviving spouse died before husband 2, then the $4,000,000 DSUE would remain intact for estate tax purposes.

  • Portability only applies to Federal estate taxes. Portability does not apply to State estate taxes. As of January 1, 2005, Florida does not have an estate tax.
  • Portability leaves the first to die spouses return open for audit. By choosing the portability election, the 2-year statute of limitations is not applicable. The first to die spouse’s return remains auditable until the death of the surviving spouse’s statute of limitations period ends.

Does this mean throw the portability by the wayside? No. It means that each estate is different and the determination needs to be made carefully by meeting with an estate planning attorney.  A client needs to fully understand the consequences of making the portability election.

Keep in mind that the portability election must be timely. You are required to make the portability election within 9 months of date of death of first spouse to die or within 15 months with an approved extension. Otherwise, you lose it.

Contact Florida Probate and Trust Litigation Attorney Thomas Upchurch of Upchurch Law for a consultation at 386-320-6169 or email him at tupchurch@upchurchlaw.comtoday.

Florida Probate and Trust Litigation Attorney Thomas Upchurch serves the entire state of Florida, serving Volusia County, Flagler County, Sumter County, and Putnam County areas which includeDaytona Beach, Port Orange, Deland, Ormond Beach, Jacksonville, Palm Coast, Orlando, Saint Augustine, and New Smyrna Beach.  Areas he serves in South Florida include Miami, Ft. Lauderdale,Coral Springs, and Coral Gables  and in West Florida include Tampa and Clearwater — Upchurch Law may still handle your matter if your city is not listed.

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