Throughout a large majority of my 35-year career as a trusts and estates lawyer, formula-based estate planning for spouses was common. Spouses’ wills or revocable trust instruments would frequently provide that, at the death of the first of them to die, the smallest amount (or fractional share) that, if allowed as a marital deduction, would cause the predeceased spouse’s estate to incur no estate tax was to be distributed to the surviving spouse or to a trust qualifying for the marital deduction. The residue of the estate (or the remaining trust property) would pass in a non-marital deduction disposition (usually to a family trust for the concurrent benefit of the surviving spouse and descendants). Alternatively, it was appropriate in some estate-planning situations to provide that, at the death of the first spouse to die, the largest amount (or fractional share) that could pass in a non-marital deduction disposition without causing the predeceased spouse’s estate to incur estate tax was to be distributed to a family trust, and the residue (or remaining trust property) was to be distributed to the surviving spouse or to a trust qualifying for the marital deduction.
Portability, along with the historically high and annually increasing applicable exclusion amount, both of which became “permanent” parts of the law with the enactment of the American Taxpayer Relief Act of 2012 (ATRA), have rendered largely obsolete these formerly common estate-planning approaches. Directing the predeceased spouse’s applicable exclusion amount to a family trust is no longer a standard estate-planning mechanism by which to benefit the surviving spouse and, at the same time, use the predeceased spouse’s applicable exclusion amount. Indeed, today, having a family trust come into existence at the death of a predeceasing spouse is often unnecessary and even inappropriate. With a portability election,1 the predeceased spouse’s executor2 can enable the surviving spouse to use, during life, at death or a combination thereof, the predeceased spouse’s “deceased spousal unused exclusion amount.”3 Moreover, if the surviving spouse dies owning what’s left of the predeceased spouse’s assets along with her own assets, both of those categories of assets will receive a stepped-up basis at the surviving spouse’s death.4 The portability election rules must be followed carefully,5 and there are substantive disadvantages to portability that shouldn’t be overlooked,6 but this approach is very attractive to a large number of married couples.
Using formula provisions that mandate particular dispositions of specified amounts or shares is not the only way to avoid the disadvantages of portability and, in fact, is a very rigid method by which to do so. A flexible alternative is to implement a residuary bequest to the surviving spouse in conjunction with a family trust to be funded if and to the extent the surviving spouse makes a qualified disclaimer.7 A similar result may be able to be achieved with a qualified terminable interest property election approach like the one used in Clayton.8 The surviving spouse (or the predeceased spouse’s executor) can decide, after the death of the predeceased spouse, whether to lock in a disposition at the predeceased spouse’s death that qualifies for the marital deduction (giving rise to using portability and securing basis step-up for all the couple’s assets at the surviving spouse’s death) or to use a family trust (eschewing basis step-up for all the couple’s assets at the surviving spouse’s death but avoiding some or all of the potential disadvantages of portability).9
In a post-ATRA world, there are very few circumstances in which a traditional zero-out-the-estate-tax formula approach is the best way to go. It precludes the possibility of using portability and getting basis step-up for all the couple’s assets at the surviving spouse’s death. Estate planners should be alert to this when reviewing and revising existing estate plans and designing new ones.
1. Internal Revenue Code Section 2010(c)(5)(A).
2. IRC Section 2203.
3. IRC Section 2010(c)(4).
4. IRC Section 1014(a).
5. Temporary Regulations Section 20.2010-2T(a), amplifying IRC Section 2010(c)(5)(A),provides that portability is elected by the timely filing, by the executor of the predeceased spouse’s estate, of a complete and properly prepared estate tax return. The portability election, once made, is irrevocable after the due date of the estate tax return, including extensions actually granted, has passed. Temp. Regs. Section 20.2010-2T(a)(4).
6. These disadvantages may include: (1) the surviving spouse’s losing deceased spousal unused exclusion amount upon her remarriage; (2) forfeiting the predeceased spouse’s generation-skipping transfer tax exemption; (3) subjecting to estate tax at the surviving spouse’s death investment return generated between the deaths of the spouses by what had been the predeceased spouse’s assets; and (4) not protecting what had been the predeceased spouse’s assets from the claims of the surviving spouse’s creditors.
7. IRC Section 2518.
8. See Estate of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992). See also Treasury Regulations Section 20.2056(b)-7(d) and 7(h). But cf. Charles A. Redd, “Dusting Off the Crystal Ball,” Trusts & Estates (January 2014) at p. 9.
9. See endnote 6.