Problems Regarding Recently Enacted Provisions Relating to the Portability of a Deceased Spouse's Unused (unified Gift/estate Tax) Exemption ("dsue") and Proposed Solutions to Those Problems

• Publication year: 2016
• Author: By Richard S. Kinyon & Robin L. Klomparens

Problems Regarding Recently Enacted Provisions Relating to the Portability of a Deceased Spouse's Unused (Unified Gift/Estate Tax) Exemption ("DSUE") and Proposed Solutions to Those Problems1

By Richard S. Kinyon & Robin L. Klomparens²

EXECUTIVE SUMMARY

Portability, which was enacted under the American Taxpayer Relief Act of 2012, allows a deceased spouse's unused unified gift and estate tax exemption ("DSUE") to be utilized by the surviving spouse. Portability can be extremely beneficial as it allows married couples to simplify their estate planning. Previously, the DSUE did not pass to the surviving spouse unless a credit shelter or bypass trust was utilized on the first death. Now, the DSUE can be utilized even where the first spouse passes property outright, free of trust, to a surviving spouse.

Of course, the concept was simpler than the subsequent technicalities and issues that have arisen. The first spouse's unused generation-skipping transfer ("GST") exemption does not port to the surviving spouse. Therefore, when any generation-skipping transfer tax planning is utilized, portability is not an option. Additionally, the DSUE amount is not given an annual inflationary increase. The rules also limit the use of the DSUE amount to the DSUE of the last deceased spouse. If the surviving spouse makes any gifts, the DSUE amount is used before the surviving spouse's lifetime exemption. Also, portability has made planning potentially more difficult for married couples and their legal advisers due to the income tax issues that surround the death of a first spouse or surviving spouse. If a bypass or credit shelter trust is utilized, there is no step-up in basis on the second death, unlike if property is transferred outright to the surviving spouse.

Due to the foregoing, the authors propose (1) portability of the first spouse's unused GST exemption ("DSUGSTE"), (2) inflationary index of both the DSUE and DSUGSTE, and (3) limit both of them to the net fair market value of the property passing from a deceased spouse to the surviving spouse. The authors also discuss elimination of the tax-free step-up in basis regime for assets included in a decedent's gross estate.

The above revisions will allow spouses to choose portability and simplicity more frequently. It would also allow the use of portability to be more in conformity with forming a credit shelter or bypass trust. Finally, the income tax revisions provide a rational tax system on lifetime as well as on transfers on death.

DISCUSSION

I. INTRODUCTION

The recently enacted provisions under The American Taxpayer Relief Act of 2012³ ("2012 Act") relating to the portability of a deceased spouse's unused (unified gift and estate tax) exemption ("DSUE"), which are codified in Internal Revenue Code Section 2010 ("the Code"), are well-meaning and can be extremely beneficial. Portability provides that when a spouse dies, the DSUE amount transfers over to the surviving spouse. While prior to portability a DSUE amount might have been wasted due to unbalanced ownership interests (i.e., separate property) or through an inefficient estate plan, portability allows for the surviving spouse to elect to use the DSUE amount. To take advantage of portability, however, a surviving spouse must make an election through a timely filed estate tax return to utilize the DSUE.⁴ The 2012 Act permanently set the individual federal estate tax exclusion amount at five (5) million, indexed for inflation.⁵ For 2015, the exclusion amount is $5,430,000. Thus by fully utilizing the exclusion amount this year, a couple can exclude up to $10.86 million.

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While portability seemed like a simple notion, it is wrought with complexity and difficult choices and challenges. Portability often makes it difficult for married couples and their legal advisors to decide whether to utilize the portability provisions or instead fund a credit shelter trust or by-pass trust (ABC trust in a community property state) on the first spouse's death. This is due to the many non-tax and tax-law issues and tradeoffs that must be analyzed in making that decision. If certain revisions were made to the law governing portability, it would be easier for spouses to decide whether to plan for portability or whether to use a more traditional estate plan.

II. CURRENT LAW AND REASON FOR PROPOSED CHANGES

The enactment of legislation to allow the DSUE amount to be carried over to the surviving spouse was a welcome change in the law. It allows a married couple who have no desire or need for a so-called "bypass" or "credit-shelter" trust and who do not expect to have such a need, to enable the spouse who dies first ("first spouse") to leave to the surviving spouse as much of the first spouse's estate as he or she wants outright, free of trust, or in a marital trust along with the DSUE amount. This greatly simplifies the use of what could be costly and cumbersome estate planning techniques designed and necessary to preserve the benefit of the first spouse's exemption amount not used on...