What is “Portability” and What Does it Mean for the Use of Trusts?

A new approach called portability may be worth exploring for those who have an estate large enough to be subject to estate tax.

A bypass trust still works when the value of the estate is high, but there is a new option that may serve your estate plan better. Under the present estate tax law, each person has a $5.45 million exemption from federal estate and gift taxes. The amount, indexed for inflation, goes up a little bit at the start of every year. And if your estate is larger than this, the excess is going to be taxed at 40%.

The Houston Chronicle’s article, “'Portability' is another option for spouses to avoid estate taxes,” reminds us that when you make lifetime gifts, the first $14,000 to any person each year is excluded from the gift tax. The gifted amounts in excess of this amount will use up your lifetime gift tax exemption—also equal to $5.45 million per person. So when you use up your lifetime exemption for the gift tax, you also use up your lifetime exemption from the estate tax. If you make a transfer during your lifetime over the $5.45 million limit, it’s taxed at 40%—just like the estate tax. The gift tax exemption is also adjusted for inflation and rises some each year.

Married couples get two $5.45 million exemptions, one for each spouse. However, to take advantage of the total $10.9 million, you need to take certain steps. The “old school” approach would be to create a bypass trust. In this trust, the spouse who dies first leaves up to $5.45 million in trust for the other spouse. This trust is available to the surviving spouse and isn’t subject to estate taxes when the survivor dies.

Up until 2010, if a spouse with a taxable estate died without a sound estate plan, and left his or her estate outright to the surviving spouse, there would be little to keep the property from estate taxes after both spouses pass away. Although the gift to the surviving spouse wouldn’t have generated any estate taxes because of the "unlimited marital deduction," the results was that the surviving spouse was left with all the property—but only one person's exemption from estate taxes. The exemption of the first to die was lost if a bypass trust wasn’t created. But now you don’t necessarily need to create a bypass trust.

When the first spouse to die leaves property directly to the survivor, the unused estate exemption can be added to the survivor's exemption, so it could potentially be twice the amount the survivor can give away free of gift taxes during a lifetime and estate taxes at death. The exemption is “ported” to the surviving spouse.

Bear in mind that the portability of the estate tax exemption does not happen on its own. An experienced estate planning attorney will be able to help plan out a strategy if the decision is made to use portability. An estate tax return for the estate of the first decedent spouse must be filed, and there are other requirements. Speak with your estate planning attorney to see if this is appropriate for your situation.

Reference: The Houston Chronicle (October 21, 2016) “'Portability' is another option for spouses to avoid estate taxes”