Chapter 4. Use of Exemptions

• Author: Jerold I. Horn
• Pages: 196-238

4

Use of Exemptions

PART ONE

OWNERSHIP AND PAYMENT ARRANGEMENTS

The estate tax and generation-skipping tax exemptions permit a person to

benefit himself or herself and his or her spouse and, upon the death of the

survivor of himself or herself and his or her spouse, benefit other

beneficiaries, free of estate tax and generation-skipping tax. Nevertheless,

unnecessary liability for tax can occur if a spouse dies without using his or

her exemptions, under circumstances in which the assets of the

predeceasing spouse will cause the surviving spouse to have assets that will

exceed the exemptions of the survivor.

The ability to use the exemptions of each of two spouses, regardless of

which spouse dies first, can depend upon the manner in which a married

person owns his or her assets during his or her life and provides for their

transfer upon his or her death. The use of the exemptions of a predeceasing

spouse can require that the predeceasing spouse transfer his or her property

in such manner as does not cause the surviving spouse to own (or be

deemed to own) it.

The procedure known as “portability” can permit a surviving spouse to

use any unused portion of the United States estate tax exemption of his or

her last predeceased spouse. However, portability does not apply to the

generation-skipping tax or to the estate taxes of at least some states. Further,

it does not avoid tax upon increases in value that occur after the death of the

predeceasing spouse.

A lawyer can prepare documents that can implement the clients’ plan.

However, the clients must arrange the ownership and transfer of their assets

in such manner as enables the documents to operate properly.

A prerequisite to the ability of each spouse fully to use all of his or her

exemptions is that each must own, in his or her separate name (or in the

name of the trustee of his or her revocable trust), assets which (unlike, for

example, assets held between spouses in joint tenancy or tenancy by the

entireties or assets that pass from a predeceasing to a surviving spouse by

means of a beneficiary designation) will not pass outright to the surviving

spouse. Assets that are intended to use exemptions must not be subject to

payment arrangements (such as, for example, joint tenancy, tenancy by the

entireties, community property with right of survivorship, transfer-on-death,

payable-on-death, and beneficiary designation) that “force” the assets

outright to a surviving spouse. For purposes of this analysis, assets that can

serve this function are “Shelterable Assets,” meaning assets that are owned

by a spouse and that upon the death of the owner can benefit the surviving

spouse without the surviving spouse having to become the owner for estate

tax purposes. Further, the words Maximum Exemptable Amount of a

spouse describe the largest of the exemptions that (after taking into account

prior uses) is available to the spouse.

1. If the sum of the values of the Shelterable Assets of the two

spouses exceeds in value the sum of the Maximum Exemptable

Amounts of the two spouses, each spouse should own Shelterable

Assets at least as great in value as his or her Maximum Exemptable

Amount.

2. If the combined net worth of the two spouses is less than the sum

of the least available exemption of one spouse and the least

available exemption of the other, no lifetime adjustment of

ownership is needed between the spouses, and each can leave all of

his or her assets outright to the other without attracting liability for

United States or state estate tax.

3. If the value of the Shelterable Assets of one spouse exceeds his or

her Maximum Exemptable Amount, and the value of the

Shelterable Assets of the other spouse is less than his or her

Maximum Exemptable Amount, the first should make lifetime

gifts of Shelterable Assets to the second to the extent of the lesser

of (i) the insufficiency of the second and (ii) the excess of the first.

Lifetime gifts from the donor spouse outright to the donee can accomplish

desired adjustments. The donor should not make any gift to the revocable

trust of the other spouse. Outright gifts between spouses who are citizens of

the United States are deductible for gift tax purposes, without limit. By

contrast, gifts from a person to a spouse who is not a citizen of the United

States are not deductible, but to the extent of an aggregate of a particular

amount of outright gifts during any calendar year they are excludable, from

the taxable gifts of the donor. Any change of ownership, and any

contribution to any joint tenancy or tenancy by the entireties, under

circumstances in which the donor increases the value of the interest of the

donee and is unable unilaterally to restore the increase to himself or herself,

is a gift for this purpose. This analysis is subject to these special rules for

gifts to noncitizen spouses.

Even if upon the death of a person too much of his or her property

appears destined to pass outright to his or her surviving spouse, and thus not

to fund the exemptions of the person who died, the survivor might salvage

some or all of the exemptions of the predeceasing spouse by using a

disclaimer. By means of a disclaimer, the survivor can avoid the receipt of

the disclaimed property and, instead, cause the disclaimed assets to pass to

a trust for the benefit of the disclaimant. Still, not even this type of planning

can salvage a situation in which too little (rather than too much) property

flows from the predeceasing spouse. Accordingly, proper titling is

important even if the possibility of disclaimers is being contemplated.

Not all (or, in a given case, even necessarily any) assets are Shelterable

Assets or available to use as Shelterable Assets.

(a) First, any assets that should pass outright to the surviving spouse

upon the death of the predeceasing spouse are not available.

(b) Second, upon the death of the owner, certain assets, such as interests

in qualified plans of deferred compensation, individual retirement

accounts, and tax-deferred annuities, produce better results for

income tax purposes if they are payable outright to a surviving

spouse rather than to a trust. Accordingly, absent special

circumstances, the preferred planning usually is (i) to name the

surviving spouse as first beneficiary of interests in qualified plans of

deferred compensation and individual retirement accounts and (ii) to

provide for passage to a trust only to any extent that the spouse

disclaims. Thus, usually, these interests are only conditionally

available to use the exemptions of the owner upon the death of the

owner, and the use of other assets usually is preferable.