Each of my three middle-school children recently came to my wife and me with two “first-world” problems. Ahead of various upcoming trips away from home this summer, each of them asked for more portable pillows and more portable electronic devises. These portability problems remind me of certain planning discussions about the portability of one’s estate tax exemptions. In this month’s update, I summarize the portability of federal gift and estate tax exemptions, and what factors should be considered in implementing a plan relying solely on a portable federal exemption.
Current Federal Exemption Amounts
The federal “unified credit” against federal estate and gift taxes, commonly referred to as the exemption, currently stands at $12,920,000. If no action is taken before January 1, 2026, the exemption amounts set by the 2017 Tax Cut and Jobs Act (“TCJA”) will expire, and the federal exemption will be reset to the 2016 exemption amount levels. Adjusted for inflation, the exemption amount will be approximately $7.0 million per person.
Rules for Porting Unused Exemption at First Death
Under federal law, a surviving spouse can use any unused federal exemption of his or her late spouse, also known as the “predeceased spouse.” The predeceased spouse’s unused exemption (“PSUE”) can be “ported” to the surviving spouse if a federal estate tax return is prepared and filed following the first death on a federal estate tax return. The surviving spouse can subsequently utilize the PSUE, as well as his or her own personal exemption amount, to shelter additional assets from federal gift or estate taxes. Please note the following important rules:
- The PSUE is equal to the unified credit available at the time of transfer. For example, if the predeceased spouse dies in 2023, the PSUE amount for use by the surviving spouse would be $12,920,000.
- An estate tax return must be filed on behalf of the predeceased spouse to port the PSUE.
- This estate tax return must be filed within five years of the predeceased spouse’s death.1
Traditional Planning With Credit Shelter Trusts
Historically, the use of a “Credit Shelter Trust,” also known as a “Tax Savings Trust,” has been used to lock in the benefit of the unused federal estate tax exemption at the first death. Under this structure, assets are allocated to a legally binding trust after the death of the first spouse. The predeceased spouse’s federal estate tax exemption is then allocated to the Credit Shelter Trust. This “traditional” planning strategy, while requiring a surviving spouse to set aside assets in one or more separate accounts following the first death, might nonetheless be the more appropriate legal structure than relying solely on the portability of the PSUE in one of following four situations:
Blended Family Situations
If the PSUE is ported to the surviving spouse, the surviving spouse has full legal control over how the PSUE is subsequently utilized. The surviving spouse has no legal requirement to use PSUE for gifts to the children of the predeceased spouse or allocate assets to the children of the predeceased spouse.
Minnesota Estate Taxes
Unlike the federal exemption, the Minnesota estate tax exemption of $3.0 million per person is not portable. Therefore, if no Credit Shelter Trust is funded with assets following the predeceased spouse’s death, the Minnesota estate tax exemption is lost. 2
Generation-Skipping Transfers
Similarly, the exemption from federal generation-skipping transfer taxes, often referred to as “GST tax,” is not portable. Families can create certain types of trusts, called “generation-skipping” trusts, that will make assets available to their children, but also structured to avoid federal and state estate taxes at the death of the beneficiary/child. 3 Just as a Credit Shelter Trust must be implemented to minimize Minnesota estate taxes, a Credit Shelter Trust must be implemented to make full use of both spouse’s GST exemptions.
Asset Appreciation Considerations
Finally, clients might fund the Credit Trust with assets following the first death to fully leverage the exemption for subsequent appreciation. If the assets contributed to a Credit Trust following the first death appreciate at a rate faster than any rate of increase in the federal unified credit before the second death, the family will avoid estate taxes on such asset appreciation.4
In our family’s case, our children are now in possession of more portable pillows and devises for use in their myriad summer activities. My wife and I are keeping our original, non-portable pillows and devises, even for our summer travels. Regarding the portability of your clients’ federal estate tax exemptions, our firm is ready to help you and your clients determine whether their exemptions should be portable, or whether the original version of the planning strategies would be more appropriate.
NOTES:
1 IRS Rev Proc. 2022-32. Please note that this is different than the nine-month disclaimer deadline for funding a disclaimer-style credit shelter trust.
2 At a current tax rate of 16%, failing to allocate assets to a Credit Shelter Trust results in an unnecessary estate tax of approximately $480,000.
3 Through the use of a GST exemption, the IRS effectively limits the amount of assets that a taxpayer can gift to generation-skipping trusts, since these trusts effectively skip a generation of estate taxes. The use of GST exemption allows for clients to maximize the amount of assets that can be transferred to these generation-skipping trusts.
4 Assets in a Credit Shelter Trust are not allowed a step-up in cost basis at the death of the surviving spouse. This strategy would lose the “step up” cost basis benefit that would have been achieved if the assets had been owned by the surviving spouse.