By Phoebe Stone, JD, MA (Bioethics)
When creating an estate plan for a married couple, there are many ways to plan for its division into marital and nonmarital shares upon the death of the first spouse. The circumstances and the client’s wishes (as informed by your professional guidance) will dictate the most appropriate design. For example, planning for couples of very modest means will likely include different choices than planning for high-net-worth couples; planning for an elderly couple in a decades-long marriage who have only shared children may look different from planning for blended families. To best serve your clients, it is critical that you understand the options available and are able to communicate the benefits and burdens associated with each option in ways your clients will understand so that your expertise can appropriately guide their choices.
This article will review relevant tax considerations; explore the requirements associated with distributions that generally qualify for the unlimited marital deduction, including general power of appointment (GPOA) trusts, qualified terminable interest property (QTIP) trusts, and spousal elective share rules; and, describe common funding formulas and choices. Sometimes, confusion stems from the inconsistent use of common terminology (e.g., credit shelter trust, bypass trust, and family trust); this article also aims to demystify such terminology by defining terms and identifying synonyms.
Tax Considerations and Portability: a Primer
When dealing with any estate plan, it is important to keep transfer taxes in mind—at both the state and federal levels. At the federal level, transfer taxes may include estate tax, gift tax, and generation-skipping transfer (GST) taxes. At the state level, transfer taxes may include state-level estate taxes (separate from, and in addition to, the federal estate tax), inheritance tax paid by the recipient of inherited property, and state-level gift and/or GST taxes. This article will focus on federal and state estate taxes.
At the federal level, the basic exclusion amount (BEA, also called the exemption amount or lifetime gift and estate tax exclusion amount) applies to all US citizens and domiciliaries (US persons). The BEA changes annually; in 2023, the BEA is $12.92 million per person, meaning that a US person who dies in 2023 can transfer at least $12.92 million via lifetime gifts and upon death before their estate is subject to federal taxation. When lifetime gifts in excess of the annual federal gift tax exclusion amount are made to recipients other than US citizen spouses, such gifts must be reported; while larger gifts are not necessarily taxable, they do eat into the donor’s remaining lifetime gift and estate tax exclusion amount.
The unlimited marital deduction provides that any assets transferred, via a qualifying transfer to a citizen spouse (discussed in more detail below), either during life or upon death, can pass tax-free. It applies to all legally married couples, provided that the spouse is a US citizen. Note that while all US persons (citizens and domiciliaries) get the benefit of the BEA, only US citizen spouses get the benefit of the unlimited marital deduction.
Portability is another important concept. It is often best explained via an example: Imagine Tom and Cindy are legally married, and both are US citizens living in California, where there is no state-level estate tax. Tom died in 2022, when the BEA was $12.06 million per person. Tom’s gross estate is $4 million; he leaves everything to Cindy, his surviving spouse, via a transfer that qualifies for the unlimited marital deduction. Thus, Tom also leaves behind $12.06 million of unused exclusion amount because he did not dip into his BEA at all to make lifetime gifts or transfers upon death; this leftover $12.06 million is known as the deceased spouse’s unused exclusion amount (DSUE). Via portability, Cindy, as the surviving spouse, can “port” Tom’s DSUE to herself, effectively adding $12.06 million of exemption to whatever the BEA is in the year Cindy dies. So, if Cindy lives until 2030, when the BEA is hypothetically $6 million per person, Cindy will have an applicable exclusion amount (AEA) of $18.06 million ($6M BEA + $12.06M ported DSUE).
Portability elections are made via a timely filed 706 Estate Tax Return Form and are generally only available for federal estate tax purposes; however, some states that impose an estate tax have begun to allow state-level portability elections. Especially when the BEA is high and the decedent spouse leaves behind a substantial DSUE, it may be advisable to file a Form 706 for the sole purpose of electing portability for the surviving spouse; this will ensure that the survivor’s estate will be shielded to the maximum extent possible upon the survivor’s death, even if the BEA has decreased substantially or the survivor’s estate has increased substantially, in the intervening years.
Marital and Nonmarital Shares
Upon the death of the first spouse, estate plans often direct division of assets into marital and nonmarital shares. Generally, the marital share relies on the unlimited marital deduction to shield it from. . .
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