Although the new very large exemptions will not impact most people, estate and financial planners have to assume for now that the 2025 sunset will happen and that most of our clients will still be facing the $5 million individual estate and gift tax exemptions. These high exemption levels when combined with the “portability” election will lead many individuals to believe they no longer have any tax planning to worry about, however, this is absolutely not the case.
The portability election was made permanent by the American Taxpayer Relief Act signed by President Obama on January 2, 2013. In general, portability is a rule allowing the surviving spouse of a decedent to utilize the deceased spouse’s unused exemption for making future lifetime transfers and/or for the use at the death of the surviving spouse. Portability, when combined with the larger exemptions we have seen this decade, has been a game changer in the estate planning world because we can recommend to fewer clients that they have to separate assets in order to fund credit shelter trusts3.
For most married couples we can now recommend wills that leave everything outright to the surviving spouse with an option for the survivor to disclaim to a marital or credit shelter trust in the event there is an unexpected estate tax issue or other non-tax reason to fund a trust, such as for creditor protection.
In the past, we would create provisions in wills that would fund testamentary credit shelter trusts, whether mandatory or subject to a disclaimer. Now, however, for couples who have combined estates of less than the combined federal exemption (and who desire that assets pass in trust for their spouse rather than outright) we would likely want to fund a marital trust at the second death. Every client’s situation will vary of course, but for those who will most likely not have a taxable estate we want to ensure that their children will not have to pay capital gains taxes on what they inherit once they turn around and sell those assets.
To the extent that assets can pass outright to a surviving spouse or fund a marital trust for which a QTIP election can be made to take advantage of the unlimited marital deduction4, those assets will all be included in the survivor’s estate and so will receive a step up in basis at the surviving spouse’s death. Because of the available portability election, the surviving spouse will now have use of their deceased spouse’s exemption as well as their own exemption at the survivor’s death. For those couples safely below $10 million in assets (remembering we have to assume that the sunset will occur in 2025), our focus has now entirely shifted to minimizing income taxes for future generations when they later sell the assets they inherit.
What do we do about those credit shelter trusts created many years ago where we still have a surviving spouse who is living? These families have options to consider that would involve transferring low basis assets from the trusts to the surviving spouse during such spouse’s lifetime so that they will be owned by such spouse at their death and thus would receive a step up in basis. It is possible such a distribution/termination will create gift tax issues in some situations, however with the current $11.18 million exemption for both estate and gift taxes, it is the perfect time to take advantage of transferring those assets out of the trust even if it means there may be a gift to the children as the remainder trust beneficiaries after the surviving spouse’s death.
This is not the right solution for every lingering credit shelter trust out there, even if the numbers work out. Many times these trusts are created with the knowledge of possible adverse tax consequences in the future, most of the time where the testator desired to include their children as beneficiaries during the surviving spouse’s lifetime and/or to control the ultimate disposition of the assets, such as in a blended family situation.
Estate and financial planners must ask the right questions and where there are opportunities to “undo” these credit shelter trusts and save our clients or their descendants from having to pay unnecessary capital gains taxes we need to educate them of the opportunities available, because for some they may not be available after 2025.