Estate Planning with Portability in Mind, Part I
Prior to 2011, if a decedent did not fully use his or her estate and gift tax lifetime exemption, it was forever lost. Because of this potentially dramatic adverse transfer tax consequence, some estate planners proposed the concept of “portability” to Congress. In 2004, the first portability bill was introduced,1 but it wasn’t until the passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010) on December 17, 2010, that it became law.2 However, its welcomed arrival was short lived; it, like the other provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA),3 sunsets at the end of 2012.4
The frequently asked question is: “If portability is temporary, then why plan with it in mind?” Another question is: “Even if portability becomes permanent, doesn’t that mean there is less need to plan for use of exemptions?” Our answer to these questions is: If you don’t plan with portability, your clients may lose out, and failure to present this planning opportunity may negatively impact your practice.5 Thus, knowing “how to plan with portability in mind” is critical.
Portability in a Nutshell
Portability allows a surviving spouse to add his or her “last” deceased spouse’s unused exemption amount (DSUEA) to his or her basic exclusion amount (BEA).6
To use the DSUEA, the deceased spouse’s personal representative must make an election on that deceased spouse’s timely filed estate tax return and calculate the DSUEA.7 The DSUEA can be used during the surviving spouse’s lifetime or at death.8
Unfortunately, portability is inapplicable to generation-skipping transfer (GST) taxes.9 Additionally, no state has introduced the concept of DSUEA for its estate, gift, and/or GST tax purposes.
Will Portability Become Permanent?
Whether portability will become permanent is the quintessential question. Currently, as mentioned above, portability is temporary. However, President Obama’s administration would like it to continue.10 The ABA RPTE Section supports this proposal,11 as does The Florida Bar’s Real Property, Probate and Trust Law Section.12 Additionally, at the time of writing this article, two senior members of the House Ways and Means Committee, Congressmen Rangel (D-NY) and McDermott (D-WA), introduced a bill into Congress which, among other things, would make portability a permanent fixture in the estate and gift tax law.13
Factors to Consider
Clearly, one cannot be sure that portability will continue in the future; however, we believe that in representing clients (whether estates or living clients) you should present the opportunity to them while discussing its pros and cons. In determining the viability and efficacy of portability planning, the following list of factors should be considered: cost, benefit, magnitude of the couple’s estate, size of anticipated unused exemptions, ages, asset protection, marital status, growth of assets, desire for generational planning, and state estate tax concerns.
• Basis for Analysis: Comparing Plans — To analyze the factors, we believe it is best to compare two different plans: a traditional plan and a basic portability plan ( i.e., a plan with so-called “I love you” wills).14 In looking at those plans, we assume a married couple with surviving descendants.
The traditional plan provides that each spouse will have a revocable trust with by-pass (or credit shelter) and marital planning.15 Upon the survivor’s death, the assets can either stay in trust or pass outright to the descendants. comparison, the basic portability plan provides that the couple has “I love you” wills, where they leave everything outright to the surviving spouse with all assets passing outright to the descendants upon the survivor’s death. With this framework, we look at the factors.
• Cost — From the client’s perspective, perhaps the most important issue is professional cost. The most common query is: “How much will it cost me to consider portability in my estate planning?” Ultimately, the question is: “Is it worth it?” It is up to the planner to explain the costs and the benefits.
Some view portability planning only as an estate administration issue. We believe it is more than that. It is a lifetime planning, estate administration, and continuing administration issue for the client and the surviving spouse.
From the estate planning perspective, quantifying the cost is difficult. If portability goes away, then planning for it may have been a waste. Conversely, inadequate or untimely planning may cause one to re-do an estate plan later (if portability becomes permanent), thus, costing more in the long run. So, one is left with the proverbial scenario: Darned if you do; darned if you don’t. Certainly, “uncertainty,” once again, causes a quandary for both the planner and client. It leaves the planner with the tough task of explaining to the client varying options without being able to provide definitive guidance.
For trust settlement or probate administration, costs generally depend upon the estate’s size and complexities. Under our two plan scenario, our collective experience is that settlement costs of traditional plans will generally exceed basic portability plans.
Further, if an estate tax return (Form 706) is required, there will be little cost differential between the plans to prepare the return. However, there will be some added time necessary to analyze and explain why the election is being made and to document the decision.
If a Form 706 is not required,16 There is the added cost of having to complete and file a Form 706 if the only purpose of doing so is to elect portability. Added to the cost for completing and filing the return are the costs associated with analyzing, explaining, and documenting the decision.
From a post-death-continuing-administration-perspective, it is likely that the traditional plan would be more expensive to administer ( i.e., because of fees for the preparation of accountings and income tax returns for the by-pass and marital trusts, etc.)
• Benefit — As stated above, the client’s cost question really is a two-part question: “How much will it cost?” and “What’s the benefit?” We now address the benefits.
If portability becomes a mainstay in the estate and gift tax laws, in general, the benefit that is most evident is the estate tax savings from not losing the unused exemption. However, even if portability continues, it is possible to plan for portability and still lose the estate tax savings because of the so-called “last deceased spouse” rule.17
Additionally, until we have legislative action that provides for portability beyond 2012, it is entirely possible that the benefit will go away in 2013.
So what should you, as counselor, do? We believe that during this time, it is important to convey to the client the benefit of DSUEA, while explaining the possibility of losing it (entirely or in part). Arguably, most importantly, we recommend that you document the discussion.18
One of the non-apparent benefits of portability is the basis adjustment under IRC §1014 when assets appreciate. With a traditional plan, if the assets in the credit sheltered trust appreciate, they do not get a step-up in basis upon the death of the surviving spouse.19 comparison, under a basic portability plan, when the survivor dies, the appreciated assets are stepped-up.20 This step-up could be beneficial in certain circumstances.21
• Size of Estate/Size of Exemption — There is no uniform analysis to determine what size estates should consider portability. All things being equal, the authors suggest the following “rules of thumb,” if combined estates are:
• Less than the current basic exclusion amount or BEA (roughly $5 million),22 a basic portability plan could be the better route.
• Greater than the current BEA, but less than double such amount, a basic portability plan should be considered; it is not clear which would yield the better result (it would depend on a host of other factors).
• More than double, but less than four times the BEA, a traditional plan may be the better route, but the basic portability plan should still be considered.23
• More than four times the BEA, a traditional plan would probably be the better result.
When examining estate size, the advisor should remember to consider the couple’s total estate and separate estates, as well as the nature and character of the assets (i.e., marketable securities, IRAs, life insurance, real estate, etc.).
• Anticipated Growth of the Assets — If asset values increase over time, depending upon their growth, portability may be less advantageous. This is because DSUEA is fixed at the time of the first spouse’s death.24 Thus, the younger the surviving spouse (if we make the assumption that over a longer period of time that asset values increase), relying on portability may not yield a better result than using a traditional plan to take advantage of the decedent’s exemption. The following example illustrates this point.
Example 1 : Assume H and W are married. When H dies in 2011, he had a $10 million estate and W has $0 in her name. H leaves everything to W, and H ’s personal representative elects portability.25 H and W make no taxable gifts during their lives. At H ’s death, W ’s applicable exclusion amount (AEA)26 is $10 million (i.e. , W ’s BEA of $5 million plus H ’s DSUEA of $5 million). Let’s assume that W dies in 2012 and the assets have increased in value from $10 to $12 million. At W ’s death, her AEA is $10.12 million ( i.e. , her BEA of $5.12 million and H ’s DSUEA of $5 million). 27 Thus, upon W ’s death, $1.88 million ( i.e., the gross estate of $12 million less the AEA of $10.12 million) is fully exposed to estate tax.
Had H and W used a traditional plan and divided assets equally, assuming the same growth, H ’s gross estate of $5 million would have passed to the by-pass trust and would not have been taxed in his or W ’s estate. W ’s $5 million would have grown to $6 million and would have been partially sheltered by her AEA (which would have only been $5.12 million, because she would have had no DSUEA, since H used all of his AEA at the time of his death to shelter his by-pass trust). Thus, $880,000 would have been subject to estate tax (which would be $1 million less compared to the basic portability plan). Based on this example, looking only at estate taxes, one may believe that the result under a traditional plan would be superior to a basic portability plan . However, as we will explain in part two, the tax analysis needs to take one more step — the planner must analyze not only estate taxes, but he or she should consider income taxes as well, and document the analysis and conversation with the client.
• Taxpayers’ Ages — From an estate administration perspective, the older the surviving spouse, portability planning becomes more relevant. Thus, for older clients, consider making the election. This does not mean that one should not be concerned with younger survivors. Quite the contrary, the younger the taxpayer, the more likely that the DSUEA will be greater ( i.e., younger taxpayers generally have smaller estates). Moreover, it is unclear whether the survivor would have ever needed the benefit of DSUEA. But remember, the “last deceased spouse” rule is more likely to come into play with younger spouses who may remarry, versus elderly spouses who might not.
• Asset Protection — Some believe that “portability planning” equates to “simplistic planning,” such as holding all of a couple’s assets jointly ( e.g., as tenants by the entireties), and having simple “I love you” wills with the ultimate distribution to children outright. We disagree! As we will illustrate in part two, portability planning should incorporate more complex planning to take advantage of asset protection upon the first to die, and upon the death of the survivor.
• Marital Status — Marital status, combined with the client’s desires for the disposition of assets, comes into play when devising an estate plan for a client. With portability, and in particular with non-first marriages ( e.g. , second, third, fourth, etc., marriages), marital agreements will likely affect the planning. As a result of portability, prospective spouses with little assets may become more appealing — financially speaking. That being the case, if the lesser moneyed spouse passes first, assuming that his or her personal representative makes the election,28 The DSUEA could be a substantial asset to the moneyed spouse. In light of this, if the law becomes permanent, we anticipate new “portability” provisions in marital agreements.
• Generational Planning — With portability, if multigenerational planning is important to the client, since portability is not extended to the GST tax, it would probably be preferable to use a traditional plan, so that the GST exemption is not wasted upon the death of the first spouse to die.29
• State Death Taxes — Florida practitioners and residents are generally less concerned with state estate taxes, because currently there is no state estate tax in Florida. However, state estate tax is relevant for those in states which impose such a tax on their residents and for nonresidents who have real property in those states. Since states have yet to implement portability, it becomes very relevant for Florida residents with real property subject to state death taxes in other states. For clients with state estate tax issues, the planner should consider more intricate planning to minimize or eliminate the bite of the state’s tax. Thus, generally speaking, a basic portability plan will likely be inferior to a traditional plan.
Issues for Additional Guidance
Assuming that one considers the factors outlined above, the analysis does not end. The reason for this is that there are a number of unresolved issues under the new statute, and, because the resolution of some substantive issues remains unclear,30 it places further onus on the planner. We found the following to be representative of some of the more pressing issues:
• Portability Recapture — The statute allows a surviving spouse to use the DSUEA of his or her last deceased spouse.31 Because of this “last spouse” provision, it is possible to have what some have referred to as “portability recapture” or “portability clawback.” This is best explained with the following example.
Example 2 : Assume the following facts: H1, married to W, dies in January 2011. H1 and W owned all assets jointly as tenants by the entireties. In May 2011, W marries H2. Immediately after marriage W makes a gift of $10 million to W ’s children. After the gift is made, H2 dies leaving no DSUEA to W. After H2 ’s death, in January 2012, W dies with a gross estate of $4.12 million. In this case, the tentative taxable estate will be the gross estate of $4.12 million, plus the taxable gifts of $10 million (totaling $14.12 million). Since H2 ( i.e., W ’s last deceased spouse) died leaving W no DSUEA, W ’s applicable exclusion amount will be limited to her 2012 basic exclusion amount of $5.12 million. Accordingly, W will be effectively taxed on $5 million of gifts that she made to her children that she thought were covered by H1 ’s DSUEA.
Clearly, Congress can amend the statute to address this issue. There may be a regulatory fix to this, too.32
• The Joint Committee’s Example Three: Is the Errata Statement Errata? — The Joint Committee on Taxation (JCT) first published its explanation of portability and how it would work.33 To explain the statute, the JCT provided three examples. The JCT’s examples one and two provided informative guidance. However, their example three has caused much confusion, because they incorrectly calculated the DSUEA in that example.34 After initial publication, the JCT realized that in reading the statute literally, its example three was not correct and issued an errata statement.35 In that clarification statement, they indicated that if IRC §2010(c)(4)(B)(i) changed the term “basic exclusion amount” to “applicable exclusion amount,” as the JCT believed was originally intended by Congress, then their example three would be correct. The problem is that example three does not explain the statute as currently drafted; it explains a statute that may be changed in some future point in time. Thus, the JCT’s example three leaves the planner in a quandary. This is something that Congress could or should clear up to resolve the inconsistencies.36
• Does Portability Apply to Non-U.S. Residents and Citizens? — At initial blush, it would appear that portability would not apply to nonresident aliens (NRAs), since they generally have no applicable exclusion amount and no basic exclusion amounts. But, IRC §2102(b)(3)(A) provides that a higher credit will be allowed to an NRA under a treaty. Under Canada’s treaty, for example, such a credit may be allowed. It is not clear that this was intended, however. Additionally, the instructions for filing an estate tax return for a NRA does not contemplate portability.37
• Making the Election — There are a number of issues associated with the requisite election that have not yet been answered by Treasury and/or Congress, which include protective elections, using a modified estate tax return ( i.e., a possible Form 706-EZ), and how to ensure that a personal representative will make the election, if required to do so.
The statute is silent on whether a “protective election” can be made. Additionally, in general, even though estate tax preparation software has made the job of preparing and filing an estate tax return easier (than manual preparation), if one only needs to file the return to make the election, perhaps a simplified form (which we call a “Form 706-EZ” for certain estates, e.g. , estates below a certain threshold amount and without hard-to-value assets), may be warranted. Another issue not covered is how the DSUEA is (or will be) affected if an estate tax return is amended. Finally, it is unclear what happens if the personal representative does not wish to make the election or inadvertently fails to do so. Can someone else make the election on the personal representative’s behalf? Can the personal representative be forced to make the election? What if the decedent and the surviving spouse entered into a prenuptial agreement and the agreement provided that the estate would make the election? Guidance would be welcomed from the Treasury on these filing issues.
Conclusion
When portability was introduced to Congress, one of the overriding rationales for suggesting the provision was to eliminate the need for complicated planning. For context, recall that the original proposal was in 2004, on the heels of the then new “temporary” estate tax provisions of EGTRRA. Recall, too, that the gift and estate tax exemption was about $1 million, and at that time, most (if not almost all) planners believed that estate taxes would likely be repealed or made permanent well before January 1, 2010. Thus, the portability provision was likely thought of as a way to simplify planning for smaller estates, because the exemption size was much smaller than it is today.
The authors believe that the original intent of portability will, in fact, reduce the need for complex planning for some; however, we also believe that an unintended consequence of the new law is that it will make the planning more complex for others. In part two, we will suggest strategies in this area of planning.
1 For a brief history of the introduction of portability to Congress and the variations of the various bills introduced over time. See DeVlieger & Carmona, The Rules for Portability, ABA Real Property Trust and Estate (ABA-RPTE) Section e-Reports, http://www.americanbar.org/groups/real_property_trust_estate/publications/rpte_e_report_home.html.
2 Sections 303 and 304 of TRA 2010 provided that I.R.C. §§2010(c)(2)-(6) would be amended for 2011 and 2012. All references to the Internal Revenue Code shall be to the Internal Revenue Code of 1986, as such Code may have been amended (Code or IRC). Generally, references to “sections,” “§§,” “section,” or “§” shall be references to the particular section or sections of the Internal Revenue Code, unless otherwise provided.
3 PL 107-16.
4 TRA 2010 §304 provides that the portability provision shall sunset in the same manner as all of the other provisions under EGTRRA.
5 See Keebler & Shenkman, Ten Portability Malpractice Traps Practitioners Should Consider, LISI Estate Planning Newsletter #1880 (Oct. 18, 2011), available at http://www.leimbergservices.com.
6 I.R.C. §2010(c)(3)(A) provides that the BEA was $5 million in 2011. This amount is indexed for inflation under I.R.C. §2010(c)(3)(B).
Rev. Proc. 2011-52 increased the BEA to $5,120,000 for 2012.
7 According to the instructions to the 2011 Form 706, merely timely filing an accurate return would suffice for making the election. This is confirmed by Notice 2011-82 (September 30, 2011). If a timely return has not been filed and the estate was not otherwise required to file an estate tax return, all may not be lost. See Law, Portability Election — There May Be No Due Date for Smaller Estates,
LISI Estate Planning Newsletter
#1885 (Nov. 1, 2011), available at http://www.leimbergservices.com.
8 TRA 2010 §305 amends I.R.C. §2505, which applies portability to lifetime (as well as testamentary) transfers.
9 Although some believe that GST planning cannot be integrated with portability planning; it is a fallacy. There are ways to take advantage of the GST exemption with intervivos planning through the use of intervivos QTIP trusts; however, there is an income tax tradeoff. It is beyond the scope of this article to discuss this topic further, but look for future articles on this planning idea.
10 See Department of Treasury, General Explanations of the Administration’s Fiscal Year 2012 Revenue Proposals, http://www.treasury.gov/resource-center/tax-policy/Documents/Final%20Greenbook%20Feb%202012.pdf.
11 See Letter to IRS, Oct. 31, 2011, submitted by the ABA-RPTE section, http://www.americanbar.org/content/dam/aba/administrative/real_property_trust_estate/government_submissions/2011_te_portability_submission.authcheckdam.pdf.
12 See Letter to IRS at 748-753, Nov. 7, 2011, submitted by The Florida Bar’s RPPTL section, http://www.rpptl.org/Content/PDFs/Marco_Island_AGENDA_12_02_11.pdf.
13 See §2(f) of H.R. 3467 (112th Cong.), Sensible Estate Tax Act of 2011.
14 We use these two plans because it has been claimed that “portability will simplify” estate planning. In fact, the General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals issued by the Department of Treasury indicated that portability will “obviate the need for such burdensome planning.” The “burdensome planning” referred to is what we call “traditional planning” for taxable estates in this article. We challenge the Treasury’s proposition that portability will simplify planning; we think it makes planning more difficult for certain clients. Thus, we use the two different plans to illustrate our conclusion.
15 By-pass (or credit shelter) and marital trust planning contemplates that upon the first to die, a trust will be sheltered by the applicable exclusion amount and the balance of assets (if any) will be funded into a marital trust. We contemplate that both trusts will be held for the benefit of the surviving spouse for life, with the remainder passing to the surviving descendants.
16 The filing of a Form 706 is generally not necessary if the gross estate plus prior taxable gifts do not exceed the applicable exclusion amount.
17 I. R.C. §2010(c)(4)(B)(i) provides that in calculating DSUEA, one can only port DSUEA from one’s last deceased spouse. The following example illustrates this: Assume W inherited a $5 million DSUEA from her deceased spouse ( H1 ) upon H1 ’s death. W later marries H2, and H2 predeceases W having used up H2 ’s entire $5 million basic exclusion amount. As a result of H2 ’s death before W, H2 becomes W’s last deceased spouse ( H1 is no longer the last deceased spouse). Thus, the amount that H1 may have ported over to W disappears. Since H2 used his entire basic exclusion amount, W is left with no DSUEA from H1 or H2. Unfortunately in this example, H1 ’s exclusion amount is completely wasted. Another illustration of this principle can be found in the joint committee’s example two at JCS-2-11, available at http://www.jct.gov/publications.html?func=startdown&id=3716.
18 See note 5.
19 Recall that §1014 requires that the assets’ bases be adjusted to the fair market value ( i.e., a step-up, if they are appreciated or a step-down, if they are depreciated) when the assets are included in the decedent’s gross estate (the credit sheltered trust is generally excluded from the gross estate).
20 Id.
21 See part two of this article in next month’s Journal where we illustrate the benefits in more detail.
22 The authors are aware that the exemption was increased to $5.12 million in 2012, but for ease of reading and writing, the authors have referred to that amount as “roughly $5 million.”
23 In part two of this article we illustrate a modified portability plan that may allow the client to achieve the best of both worlds.
24 Under I.R.C. §2010(c)(4)(B), DSUEA is calculated at the moment of death, and it is not adjusted for inflation post death. However, as mentioned above, because of the “last deceased spouse” rule, the DSUEA could be reduced or eliminated, and it is entirely possible that Congress may reduce the surviving spouse’s basic exclusion amount, which would then reduce the DSUEA (because DSUEA is limited to the value of the surviving spouse’s basic exclusion amount ( see I.R.C. §2010(c)(4)(A)).
25 For this article, we assume that any tax election will be timely, accurate, and complete.
26 The applicable exclusion amount (AEA) is the sum of the BEA and DSUEA. I.R.C. §2010(c)(2).
27 In 2012, W ’s applicable exclusion amount would increase to $10.12 million because of inflation adjusting W ’s basic exclusion amount to $5.12 million. Note that H ’s DSUEA is not increased; there is no inflation adjustment for DSUEA.
28 When advising the client with a pre- or post-nuptial agreement, the authors suggest that one consider how portability will be elected and who will bear the cost of the election. See part two (in next month’s Journal ) for some planning ideas.
29 But see note 9.
30 The IRS issued Notice 2011-82 in light of some of the unclear issues, and requested the public’s comment.
31 I. R.C. §2010(c)(4)(B)(ii).
32 See note 11 for the paper from the ABA-RPTE Committee to Treasury.
33 JTX-55-10, http://www.jct.gov/publications.html?func=startdown&id=3716.
34 The JCT’s example three at 53, http://www.jct.gov/publications.html?func=startdown&id=3716. In that example, the JCT concludes: “Under the provision, Husband 2’s applicable exclusion amount is increased by $4 million, i.e., the amount of deceased spousal unused exclusion amount of Wife.” We believe that the DSUEA in that example should be $2 million (not $4 million).
35 JTX-20-11, http://www.jct.gov/publications.html?func=select&id=50.
36 Anecdotally, in the proposed legislation by Congressmen Rangel and McDermott, there is an attempted fix incorporated into that bill . See note 13.
37 For a more detailed explanation, see DeVlieger & Carmona, The Rules for Portability.
Lester B. Law is a managing director and member of the National Wealth Strategies Group at U.S. Trust in Naples. He is board certified by The Florida Bar in wills, trusts, and estates law. He is an active member in The Florida Bar RPPTL’s Trust Law, Estate and Gift Tax Law, IRA, and Insurance committees. He is also a vice chair of the Estate and Gift Tax Subcommittee for the ABA’s RPTE’s Income and Transfer Tax Group.
Andrew Huber is a senior vice president and wealth strategist at U.S. Trust in Palm Beach. He received his J.D. from the University of Miami School of Law and LL.M. (tax) from the University of Florida, College of Law. He is also a director for The Florida Bar’s Tax Section, where he currently serves as co-chair of the education division.
The examples in this article are for illustration purposes only. The opinions of the authors expressed herein are their own and do not necessarily reflect that of U.S. Trust Bank of America Private Wealth Management, Bank of America, N.A., Bank of America Corporation, any of its subsidiaries, and/or affiliates.
This column is submitted on behalf of the Tax Section, Domenick R. Lioce, chair, and Michael D. Miller and Benjamin Jablow, editors.
