The Wealth & Wisdom Blog

Spring is finally here. The grass is green, the trees are budding, and Mother’s Day is this Sunday. It also means that my portable television can now be transported outside, where I can enjoy streaming baseball games by our backyard firepit. My portable television is more useful to me now, in May, then it was back in January. Similarly, certain tax benefits, such as the Minnesota estate tax exemption, are most beneficial if used at the right time. In this month’s update, I summarize the implications of the lack of portability of the Minnesota estate tax exemption.
An estate tax exemption is the amount that can be distributed to family members free of estate taxes at death. Currently, the federal estate tax exemption is $13.99 million, and the Minnesota estate tax exemption is $3.0 million.1 Assets directed to a surviving spouse, or to a trust for the benefit of a surviving spouse, following the first death between spouses pass free of estate taxes through the “unlimited marital deduction.” Under Minnesota law, however, this transfer merely adds to the assets owned by the surviving spouse without accounting for the deceased spouse’s Minnesota estate tax exemption.

Earlier this winter, a bill was proposed in the Minnesota Senate to make the Minnesota estate tax “portable” as between spouses. This legislation, however, has not yet been enacted. Unless such legislation is enacted, Minnesota married residents with assets exceeding $3.0 million are advised by our firm to create a Family Trust to properly utilize the exemption of the first spouse to die. 2 If this Family Trust structure is properly implemented, a family can fully utilize the Minnesota estate tax exemptions of both spouses.
For widows or widowers who have implemented this plan, it might seem as much fun as watching my portable television outside in January. Here are three common issues that arise in implementing a Family Trust, in comparison to ownership by the surviving spouse

• Administrative and Income Tax Hassle: The Family Trust is a separate legal entity. As a result, the assets contributed to the Family Trust must be kept in separate accounts from the surviving spouse’s assets, and separate tax returns for the Family Trust must be filed annually. 3
• Capital Gains: Assets contributed to a Family Trust will not receive a “step up” in cost basis at the second death. Families who see appreciation in the Family Trust assets will have to plan for future capital gains taxes. 4
• Change in Life Circumstances: In some cases, the surviving spouse does not have the legal right to change how assets of the Family Trust are distributed following the surviving spouse’s lifetime. 5 A change in life and family circumstances is therefore more problematic for certain families who have assets owned by a Family Trust.

If Minnesota residents are allowed to “port” their estate tax exemptions to their surviving spouse, then it would be possible to avoid all three of these hassles. Just as I would rather use my television outside in the summertime, so also it is much preferable to use the Minnesota estate tax exemption at the right time. I will keep you informed of any further legislative action on Minnesota portability rules.

1 A Minnesota estate tax is imposed on Minnesota residents or any non-resident who owns business assets or real estate assets in Minnesota.
2 The Family Trust structure is referred to by other planners as a “Credit Shelter Trust” or a “tax savings trust.”
3 The Family Trust files a trust tax return. Taxable income of the Family Trust is taxed either to the Family Trust itself, at higher/compressed rates, or else to the spouse or other beneficiaries at their personal income tax rates.
4 Non-qualified assets owned by the first spouse to die receive a full step-up in cost basis at the first death. Assets in a Credit Shelter Trust are not allowed a (second) step-up in cost basis at the death of the surviving spouse.
5 If the Family Trust is automatically created, the surviving spouse may be able to exercise a power, called a power of appointment, to direct remaining assets at his or her death. In contrast, a disclaimer-style Family Trust cannot be structured to permit the exercise of a special power of appointment.