UNDERSTANDING
THE ESTATE TAX EXEMPTION, THE UNLIMITED MARITAL DEDUCTION, AND PORTABILITY.

Understanding

the Estate Tax Exemption,

the Unlimited Marital Deduction, and

Portability

 

Many people have heard the phrase "estate tax" but are surprised to learn that relatively few estates are currently subject to federal estate tax. Three important concepts often determine whether estate tax planning is necessary:

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• The Estate Tax Exemption;

• The Unlimited Marital Deduction; and

• Portability.

 

Understanding how these rules work together can help families make informed estate planning decisions and preserve wealth for future generations.

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What Is the Federal Estate Tax?

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The federal estate tax is a tax imposed on certain transfers occurring at death.

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Generally speaking, the tax applies to the value of assets owned by a person at death, including:

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• Real estate;

• Investment accounts;

• Business interests;

• Life insurance in certain circumstances;

• Other property interests.

 

The estate tax is separate from income taxes and capital gains taxes.

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What Is the Estate Tax Exemption?

 

The Estate Tax Exemption is the amount that may pass free of federal estate tax. For many families, the exemption determines whether sophisticated tax planning is necessary. The larger the estate, the more important exemption planning may become.

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What Is the Unlimited Marital Deduction?

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The Unlimited Marital Deduction is one of the most powerful concepts in federal estate tax law. Generally speaking, assets passing to a surviving spouse may qualify for an unlimited deduction from the taxable estate.

 

Example:

John dies owning: $15,000,000

He leaves all assets to his wife, Susan.

Because the transfer qualifies for the Unlimited Marital Deduction, no federal estate tax may be due at John's death, even if the estate exceeds the exemption amount.

The tax is effectively postponed until Susan's death.

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Does the Marital Deduction Eliminate Estate Tax?

 

Not necessarily.  The Unlimited Marital Deduction often delays estate tax rather than eliminates it.

 

Example:

John leaves $15,000,000 to Susan.

No estate tax is due at John's death.

Years later, Susan dies owning: $18,000,000

Estate tax planning may then become important when Susan's estate is administered.

For this reason, many estate plans incorporate trust provisions designed to preserve both spouses' exemptions.

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What Is Portability?

 

Portability is a federal tax concept that allows a surviving spouse to utilize a deceased spouse's unused estate tax exemption. The deceased spouse's unused exemption is often referred to as the Deceased Spousal Unused Exclusion Amount (DSUE).

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Example:

John dies owning: $5,000,000

His exemption amount exceeds the value of his estate.

As a result, a substantial portion of John's exemption remains unused.

If a timely estate tax return is filed and portability is elected, Susan may be able to add John's unused exemption to her own exemption.

This can significantly increase the amount Susan may transfer free of estate tax at her death.

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Why Is Portability Important?

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Before portability was enacted, many married couples relied heavily upon complex trust planning to preserve both spouses' exemptions. Portability provides additional flexibility and may simplify planning for some families. However, portability does not necessarily eliminate the need for trusts.

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What Portability Does Not Do:

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Portability is helpful, but it has limitations.  For example, portability generally does not:

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• Protect appreciation occurring after the first spouse's death;

• Provide creditor protection;

• Protect assets from remarriage concerns;

• Provide divorce protection for beneficiaries;

• Preserve generation-skipping transfer tax exemptions.

 

Trust planning may still be beneficial even when portability is available.

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Example: Married Couple with $20 Million

John and Susan have a combined estate worth: $20,000,000

 

Without Planning

John dies.

All assets pass to Susan.

Susan later dies owning the entire estate.

Estate tax exposure may exist depending upon exemption amounts in effect at that time.

 

With Portability

John's unused exemption may be preserved through a portability election.

Susan may benefit from both exemptions.

 

With Trust Planning

Additional opportunities may exist to:

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• Preserve exemptions;

• Protect appreciation;

• Provide creditor protection;

• Benefit future generations.

 

Why Wealthy Families Still Use Trusts

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Many people assume portability has eliminated the need for estate tax planning. In reality, trusts may continue to offer significant benefits. Examples include:

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• Credit Shelter Trusts

Designed to preserve exemption amounts and future appreciation.

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• Dynasty Trusts

Designed to benefit multiple generations.

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• Generation-Skipping Trusts

Designed to preserve family wealth while minimizing transfer taxes.

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• Tax Basis Optimization Planning

Designed to maximize income tax benefits for future beneficiaries.

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Example: The Difference Can Be Significant

Assume John dies owning assets worth: $10,000,000

Those assets are expected to grow substantially.

If the assets appreciate to: $20,000,000 before Susan's death, the manner in which the assets were structured may significantly affect future estate tax exposure.

Proper planning can make a substantial difference.

 

Do Most Families Need Estate Tax Planning?

 

Not necessarily.

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Many families are more concerned with:

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• Probate avoidance;

• Asset protection;

• Beneficiary protection;

• Incapacity planning;

• Capital gains tax planning.

 

However, families with substantial assets should periodically review their plans to ensure they remain prepared for future changes in tax law.

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